Goldman Sachs Found “Short” on Sales of Securities by the SEC

Goldman Sachs has found itself in hot water once again after violating the SEC’s Regulation SHO Rule 203(b)(1). This regulation was enacted in 2005 to monitor the use of short sales and to prevent “naked shorting,” the act with which Goldman has been charged by the SEC. Naked short sales involve “selling stock short without first locating the shares for delivery,” according to the New York Times. Goldman Sachs violated this regulation from November 2008 to mid-2013.

The SEC’s administrative proceeding order lays out the basis of the settlement, which Goldman agreed to, and contains a cease and desist order. According to this proceeding, Goldman failed to meet the “locate” requirement of Regulation SHO because the “Demand Team,” that was charged with filling short sale requests, became overrun with locate requests and began filling them automatically. This team accessed an “autolocate” function by pressing the F3 key.  The problem with this autolocate function is that it did not consider the fact that stock sources were being depleted throughout the day. Therefore, short sale orders were being completed without actual stock inventory to back the sale. This led to inaccuracy in Goldman’s Regulation SHO locate logs and a lack of located shares for delivery in the short sales.

Goldman Sachs is now facing hefty fines and a large settlement as a result of the SEC’s investigation of these naked short sales. The SEC imposed a “civil money penalty” of $15 million. Additionally, Goldman is required to pay a settlement for claims by “the U.S. Department of Justice, the New York and Illinois Attorneys General, the National Credit Union Administration and the Federal Home Loan Banks of Chicago and Seattle.”  The total settlement comes to $5 billion: $2.385 billion will go towards a civil monetary penalty, $875 million for cash payments, and $1.8 billion in customer relief.

These numbers seem quite large, however, several other financial institutions have paid much larger fines and settlements. JP Morgan, for example, was required to pay $13 million, and Bank of America paid $16.6 billion for similar claims. According to the New York Times, Goldman may be affected in the short term by this large payment; however, the company’s stock price has increased since the announcement of the settlement. The company reported that it expects a $1.5 billion decrease in earnings in the fourth-quarter, but there is no doubt that Goldman Sachs will bounce back from this setback fairly quickly with its rising stock prices and average annual net income of approximately $7 billion.

The SEC’s order also included a cease and desist to prevent Goldman from committing any further violations of Rule 203(b)(1). Since 2013, Goldman Sachs has phased out the automated system that got it in to trouble in the first place. The members of the Demand Team must also specify where the inventory is from on the Regulation SHO locate log. This prevents the Demand Team members from automatically filling short sale requests without having previously located the source of the stock. Besides the remedies outlined in the SEC’s order, Goldman Sachs has not announced any other corrective measures, however $5 billion dollars and the measures taken to eliminate its autolocate function should be sufficient for Goldman Sachs to avoid such problems in the future.

*Dana Sisk is a 2L student at Wake Forest University School of Law. She graduated from Auburn University in 2014 with a Bachelors in International Business and concentrations in Economics and French. She hopes to practice securities and international business law upon graduation from law school.