SWS to Pay $650,000 Fine in Short Sale that Cost it $6.3 Million
March 22, 2011
Tom Steinert-Threlkeld
securitiestechnologymonitor.com
The parent company of Southwest Securities agreed to pay a $650,000 fine for its role in an improperly executed short sale that led to a $6.3 million charge against its earnings last year.
The fine will be paid to the Financial Industry Regulatory Authority (FINRA) which cited the subsidiary of SWS Group for “deficiencies in due diligence, risk assessment and written supervisory procedures” that permitted one of its correspondent firms, Cutler Securities, to proceed with a short sale with shares it was not ready to produce.
FINRA also required Southwest to designate a risk management officer to identify and manage the risks associated with its correspondent clearing services business.
As for Cutler Securities, FINRA expelled the Delray Beach, Fla., firm from the industry and barred its president, Glenn Cutler, as a result of the incident.
Cutler could not be reached Tuesday at the company’s offices.
The fine comes a day after SWS Group, which has struggled financially in the past two years, announced it had raised $100 million in fresh capital. SWS also is trying to fend off the unwanted advances of a Birmingham, Ala., investment firm that has offered $203 million to buy the company.
In the Cutler case, “we took significant remedial action including various improvements to our risk management procedures, and when FINRA subsequently commenced an investigation, SWS cooperated fully," said chief executive James H. Ross. "We are pleased to have resolved this matter and will continue to focus our efforts on behalf of our shareholders, clients and employees."
On August 6, 2009, Cutler Securities bought more than 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.
Southwest took a $6.3 million charge against its pre-tax earnings in in the first quarter of its 2010 fiscal year, as a result of the incident.
The amount was sizable. For 2009, SWS reported income from continuing operations of $24 million, down from $32 million the previous year.
The size of the short sale exceeded pre-set limits that were supposed to put boundaries on the correspondent's actions.
The fine is a relatively small additional amount to pay and comes as SWS Group tries to fend off an unsolicited offer to buy all its outstanding shares for $6.25 each, made by Sterne Agee Leach, a financial services firm based in Birmingham, Ala.
SWS said its board refused to accept the offer on the grounds it was "highly conditional and opportunistic."
Sterne Agee said that its $203 million cash offer to buy the Dallas-based brokerage and investment bank hasn't been adequately analyzed by management. Sterne Agee also said a financing agreement SWS Group entered into Monday to shake off the unsolicited buyout offer will harm existing shareholders by diluting the value of their shares.
"We believe that we can and will offer an alternative that stockholders will deem more attractive," Sterne Agee Chief Executive Jim Holbrook said in a written statement provided to The Birmingham News.
SWS Group Monday said it entered into a definitive agreement to take in $50 million each from Hilltop Holdings and Oak Hill Capital Partners.
Hilltop and Oak Hill Capital will extend a senior unsecured loan to SWS Group in aggregate principal amount of $100 million pursuant to a credit agreement.
Simultaneously with the making of the loan, SWS Group will issue a warrant to each of Hilltop and Oak Hill Capital to purchase 8,695,652 shares of common stock of SWS Group at an exercise price of $5.75, subject to anti-dilution adjustments. Upon exercise, Hilltop Holdings and Oak Hill Capital will each own approximately 17% of the company.
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