SEC CHARGES GOLDMAN, SACHS WITH ACCESS RULE VIOLATION

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
06/30/2015 12:15 PM EDT

The Securities and Exchange Commission today charged Goldman, Sachs & Co. with violating the market access rule in connection with a trading incident that resulted in erroneous executions of options contracts.

Goldman Sachs agreed to pay a $7 million penalty to settle the charges.

An SEC investigation found that Goldman Sachs did not have adequate safeguards to prevent the firm from erroneously sending approximately 16,000 mispriced options orders to various options exchanges in less than an hour on Aug. 20, 2013, after the firm implemented new electronic trading functionality designed to match internal options orders with client orders.  A software configuration error inadvertently converted the firm’s “contingent orders” for various options series into live orders and assigned them all a price of $1.  These orders were then sent to the options exchanges during pre-market trading, and approximately 1.5 million options contracts were executed within minutes after the opening of regular market trading.  Many of the executed trades were later canceled or received price adjustments pursuant to the options exchanges’ rules on clearly erroneous trades.

According to the SEC’s order instituting a settled administrative proceeding, Goldman Sachs further violated Securities Exchange Act Rule 15c3-5 by having deficient controls for preventing orders that would cause the firm to exceed its pre-set capital threshold.

“Firms that have market access need to have proper controls in place to prevent technological errors from impacting trading,” said Andrew Ceresney, Director of the SEC Enforcement Division.  “Goldman’s control environment was deficient in several ways, significantly disrupted the markets, and failed to meet the standard required of broker-dealers under the market access rule.”

Daniel M. Hawke, Chief of the SEC Enforcement Division’s Market Abuse Unit, added, “It is crucial for broker-dealers with market access to understand and control  the interaction of multiple electronic trading systems, not only to comply with Rule 15c3-5 but also to ensure the orderly operation of the markets as a whole.”

The SEC’s order made the following findings:

Goldman employed unreasonably wide price checks for its options orders during pre-market hours.  Had appropriate price bands been in place similar to those Goldman used during regular trading hours, thousands of the erroneous orders all priced at $1 would have been intercepted and not sent to exchanges.

On Aug. 20, 2013, a Goldman employee lifted several electronic circuit breaker blocks that automatically shut off outgoing options order messages once the rate of messages exceeded a certain level.

Goldman’s policies regarding these circuit breakers were not properly disseminated or fully understood by employees with responsibilities relating to the circuit breakers.

Goldman’s written policies relating to the implementation of software changes did not require several precautionary steps that, if taken, would likely have prevented the erroneous options incident.

In a separate failure that did not relate to the trading incident, Goldman did not maintain adequate controls designed to prevent the entry of orders that exceed the firm’s capital threshold.  The firm only computed its capital usage level every 30 minutes, did not have an automated mechanism to shut off orders in the event that the firm exceeded its capital threshold, and failed for several months to include a number of business units in the firm’s capital utilization calculation, thereby underestimating the firm’s trading risk.

Goldman consented to the SEC’s order without admitting or denying the findings.  In addition to paying the $7 million penalty, Goldman agreed to cease and desist from further violations of Section 15(c)(3) of the Exchange Act and Exchange Rule 15c3-5.

The SEC’s investigation was conducted by Market Abuse Unit staff Daniel Marcus, Charles Riely, and Matthew Koop and supervised by Mr. Hawke and the unit’s co-deputy chiefs Robert Cohen and Joseph Sansone.  Substantial assistance was provided by Rosanne Smith, Stephanie Morena, and Jennifer Conwell of the SEC’s National Exam Program and David Shillman, John Roeser, Richard Vorosmarti, and Carl Emigholz of the agency’s Division of Trading and Markets.

MORGAN STANLEY TO PAY $4 MILLION FOR VIOLATING MARKET ACCESS RULE

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The market access rule requires broker-dealers to have adequate risk controls in place before providing customers with access to the markets.  An SEC investigation found that Morgan Stanley, which offers institutional customers direct market access through an electronic trading desk, did not have the risk management controls necessary to prevent the rogue trader from entering orders that exceeded pre-set trading thresholds.  The trader exploited the market access and, without Morgan Stanley’s knowledge, committed a fraud that eventually shuttered the firm where he worked.  The SEC and criminal authorities have since charged the trader with fraud, and he has been sentenced to 30 months in prison.

Morgan Stanley agreed to pay a $4 million penalty for violating the market access rule.

“Broker-dealers become important gatekeepers when they provide customers direct access to our securities markets, and in this case Morgan Stanley did not live up to that responsibility,” said Andrew Ceresney, Director of the SEC Enforcement Division.  “Morgan Stanley failed to have reasonable controls in place to mitigate the risks associated with granting market access to a customer.”

According to the SEC’s order instituting a settled administrative proceeding, the rogue trader worked at Rochdale Securities LLC and routed to Morgan Stanley’s electronic trading desk a series of orders to purchase Apple stock on Oct. 25, 2012.  The orders came steadily throughout the day and eventually tallied approximately $525 million worth of Apple stock, which significantly exceeded Rochdale’s pre-set aggregate daily trading limit of $200 million at Morgan Stanley.  In order to execute the orders, Morgan Stanley’s electronic trading desk initially increased Rochdale’s limit to $500 million and later to $750 million without conducting adequate due diligence to ensure the credit increases were warranted.  Morgan Stanley’s written supervisory procedures did not provide reasonable guidance for electronic trading desk personnel who determine whether or not to increase customer trading thresholds.

According to the SEC’s order, the rogue trader at Rochdale was using these orders to commit a fraud.  He had intentionally enlarged the amount of Apple stock an actual customer wanted to purchase from 1,625 shares to 1,625,000 shares.  The trader’s scheme was to profit personally from the excess shares if Apple’s stock price increased or claim the order size was merely an error if the stock price decreased.  As it turned out, Apple’s stock price began dropping later that day, so the trader falsely claimed that he had made a mistake in placing order.  Rochdale was left holding the unauthorized purchase and suffered a $5.3 million loss.  Rochdale subsequently fell below its net capital requirements to trade securities, and ceased all business operations last year.

The SEC’s order finds that Morgan Stanley violated Rule 15c3-5 of the Securities Exchange Act of 1934.  Without admitting or denying the findings, the firm consented to the SEC’s order, which censures the firm and requires it to pay the financial penalty and cease and desist from committing or causing violations of the market access rule.

The SEC’s investigation was conducted by Eric Forni, David London, and Michele Perillo of the Market Abuse Unit with assistance from staff in the Division of Trading and Markets.  The case was supervised by the Chief of the unit Daniel M. Hawke and the Co-Deputy Chief of the unit Robert Cohen.  The SEC appreciates the assistance of the Financial Industry Regulatory Authority.