The Financial Industry Regulatory Authority (FINRA) has announced that it has fined Southwest Securities Inc., of Dallas, a penalty in the amount of $650,000 for deficiencies in due diligence, risk assessment and written supervisory procedures that permitted one of its correspondent firms, Cutler Securities, to create risk for Southwest through improper short selling. FINRA also required Southwest to designate a risk management officer to identify and manage the risks associated with its correspondent clearing services business. In addition, FINRA expelled Cutler Securities and barred its President Glenn Cutler, for Cutler Securities' violative short selling. FINRA is the largest independent regulator for all securities firms doing business in the United States.
On August 6, 2009, its second day of clearing through Southwest, Cutler Securities bought over 17.8 million shares of a stock while selling over 20.3 million shares of the same stock. Despite receiving alerts regarding this trading during the day, Southwest allowed Cutler to establish a 2.5 million share short position. Cutler Securities was unable to meet its obligation on the position, requiring Southwest to close the position, leaving it with an unsecured debit balance of approximately $6.3 million.
"Southwest's systemic failures in overseeing its clearing services led to considerable financial losses for itself, and illustrates the risks that can be created by correspondent firms," said Brad Bennett, FINRA executive vice president and chief of enforcement. "Southwest's failure to effectively monitor Cutler's reckless behavior jeopardized its ability to meet its obligations to its other correspondent firms and counterparties."
Among the deficiencies in Southwest's supervisory practices were failures to establish written due diligence policies, written criteria to determine the acceptability of potential correspondents, awareness of the proper procedure for terminating correspondent firms on an intra-day basis, appropriate trading alert parameters for many of its correspondent firms, and procedures recognizing that it had clearing and settlement responsibility for all correspondent firms that had the ability to execute trades away from Southwest.
Cutler Securities also had significant regulatory and supervisory deficiencies relating to its short sales, including a history of failing to comply with Regulation SHO by obtaining locates and properly marking order tickets, and a failure to comply with SEC Emergency Orders.
In settling this matter, Southwest and Cutler neither admitted nor denied the charges, but consented to the entry of FINRA's findings. This investigation was conducted by Donald Sullivan and Jeanne Elmadany under the supervision of Susan Light, enforcement chief counsel.