The U.S. Securities and Exchange Commission and NYSE Regulation Inc. today announced that they settled separate enforcement proceedings against a prime broker and clearing affiliate of The Goldman Sachs Group Inc.

The regulators said the violations arose from an illegal trading scheme carried out by customers through their accounts at the firm. “Both proceedings find that firm customers traded and profited by illegally selling securities short just prior to public offerings of the companies’ securities,” it said. “In connection with the illegal short sales, the SEC and the NYSE found that the affiliate, Goldman Sachs Execution and Clearing LP, violated the regulations requiring brokers to accurately mark sales long or short and restricting stock loans on long sales. The SEC and the NYSE further found that, if Goldman had instituted and maintained appropriate procedures, it could have discovered through its own records the customers’ illegal activity.”

The SEC order and the NYSE’s decision allege that Goldman’s customers carried out the illegal short-selling scheme by placing their orders to sell through the firm’s REDI System — Goldman’s direct market access, automated trading system — and falsely marking the orders “long.” Relying solely on the way its customers marked their orders, Goldman executed the transactions as long sales, they alleged. In addition, because the customers had sold the securities short and did not have the securities at settlement date, Goldman delivered borrowed and proprietary securities to the brokers for the purchasers to settle the customers’ purported “long” sales, they noted.

Both the SEC order and the NYSE decision find that Goldman’s exclusive reliance on its customers’ representations that they owned the offered securities was unreasonable. As a result, they censured Goldman for its conduct and compelled the firm to pay US$2 million in civil penalties and fines. The SEC order also directs Goldman to cease and desist from committing or causing any violations or future violations.

Goldman consented to the order and decision without admitting or denying the findings made by the SEC or the NYSE.

In determining to accept Goldman’s offers of settlement, the SEC the NYSE considered remedial measures taken by Goldman. The SEC previously brought a settled civil injunctive action against two of Goldman’s customers who had engaged in the illegal short sales and who, pursuant to the settlement, paid over US$1 million in disgorgement and civil penalties.

Linda Chatman Thomsen, director of the SEC’s Division of Enforcement, said, “Customers now have direct market access platforms such as REDI and other automated trading systems, which enable brokers to execute larger volumes of trades more quickly and efficiently for their customers. However, as this case makes clear, direct access does not obviate a broker’s own responsibilities under the commission’s short sale rules, and it certainly does not allow a broker to ignore apparent discrepancies indicating illegal trading by its customers.”

Susan Merrill, executive vice president of Enforcement, NYSE Regulation, said, “Blind reliance on customer representations that the customer is long the securities being sold is inappropriate when a firm is confronted with a customer’s repeated failures to deliver and other evidence of improper short selling.”