Illegal Trading of Self-Service Customers

In recent years there are securities firms providing their customers with some direct market access platforms which enable brokers to execute larger volumes of trades more quickly and efficiently for their customers. However, direct access does not obviate a broker's own responsibilities to detect and prevent illegal trading by its customers.

SEC and NYSE recently settled separate enforcement proceedings against a prime broker and clearing affiliate of Goldman Sachs Group for its violations arising from in an illegal trading scheme carried out by customers through their accounts at the firm.

Both proceedings find 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.

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. Obviously Goldman's exclusive reliance on its customers' representations that they owned the offered securities was unreasonable.

For more than two years, beginning in March 2000, the customers' pattern of trading and Goldman's own records reflected that they were selling the securities short. The customers did not deliver to Goldman in time for settlement the securities they purported to sell long, but rather, had to borrow the securities from Goldman to settle all of their sales.

Goldman's records also reflected that its customers covered their short positions with securities purchased in follow-on and secondary offerings after executing their sales. Had Goldman instituted and maintained procedures reasonably designed to detect these significant trading disparities, it could have discovered the pattern of unlawful trades by its customers.

This case clearly indicated that a broker can't turn a blind eye to the "self-service" trading of customers.