Goldman Sachs Group Inc. agreed to pay $6.75 million to eight U.S. exchanges to settle claims over the way it handled options trades from January 2004 through May 2010, according to a document on the Chicago Board Options Exchange’s website.
The New York-based securities firm mislabeled certain options orders as originating with customers instead of brokers or market makers, potentially giving them access to preferential treatment, according to a letter of consent. Goldman Sachs, which was censured by the exchanges, neither admitted nor denied wrongdoing.
The Financial Industry Regulatory Authority, which oversees more than 4,300 brokers, has been assessing how firms categorize orders in sweeps it is conducting to ensure they are complying with rules, Richard Ketchum, chairman and chief executive officer of Finra, said at a conference in Washington on Sept. 20. Mismarking orders affects the execution priority given to users, the official audit trail of executions, and the fees paid to exchanges, he said.
“Historically, traders have attempted to get better pricing from exchanges by representing someone as a customer,” Stephen Solaka, a former CBOE member who oversees about $60 million including options as co-founder of Belmont Capital Group in Los Angeles, said in a phone interview. “The exchanges are competing for customer order flow and would bend over a little more for a customer than they would for a market maker.”
Buy and sell requests from market makers, brokers, public customers and professionals are treated differently by many exchanges, with those from customers usually executing before others. The fees exchanges charge may vary based on the type of company or individual submitting the order. Goldman Sachs employed two order-entry systems that failed to identify the source of options orders, according to the disciplinary action.
“We’re pleased to have settled these matters,” Michael DuVally, a spokesman for Goldman Sachs, said by phone.
The G2 and Stride systems Goldman Sachs employed were deficient because they didn’t allow users to select different codes to identify the orders properly, the document said. The Stride system coded all orders as coming from customers. Some orders may have received priority in transactions over others because they were mislabeled, the document said.
Goldman Sachs “failed to maintain supervisory systems and controls that were reasonably designed to achieve compliance with exchange rules,” the CBOE document said. The broker also didn’t immediately fix its coding deficiencies when problems were identified by its employees on several occasions, the letter of consent said.
Nasdaq Options Market said in its disciplinary action that Goldman Sachs’s compliance, equity derivative sales and sales technology groups didn’t communicate adequately about the development of G2 and Stride. System developers also didn’t understand the broker’s client base for options, contributing to deficiencies in the order-entry platforms, it said.
CBOE, the largest U.S. options exchange, will get $3.75 million of the total fine, CBOE Holdings Inc. said. The other exchanges include the International Securities Exchange, Nasdaq Options Market, Nasdaq OMX PHLX, NYSE Amex Options, NYSE Arca Options, Bats Options and BOX Options Exchange, according to the document. ISE said in a separate notice it will get $1.1 million of the total amount.
Goldman Sachs separately reimbursed exchanges for the difference between the fees it paid to trade on their venues and what it owed them, CBOE said. ISE said the broker paid almost $900,000 in uncollected fees for improperly marking orders as coming from customers instead of brokers or market makers. ISE in New York is owned by Frankfurt-based Deutsche Boerse AG.
Finra’s focus on the labeling of options orders is part of a broader review of controls brokers employ to ensure that buy and sell requests are properly identified. The private-sector regulator has uncovered a “large number of firms that are either misreporting positions or not reporting them at all,” flouting obligations concerning their so-called large-options positions, Ketchum said in September.
The misuse of market-maker exemptions for firms that must otherwise locate shares before engaging in short sales is another area of investigation, Ketchum said. Finra is probing excessive quotation message traffic caused by algorithms and enhancing its examination and market surveillance programs to uncover manipulative activity, he said.