updated 3/14/2007 7:17:47 PM ET 2007-03-14T23:17:47

Goldman Sachs Group Inc.’s clearing unit has agreed to pay $2 million in civil penalties to settle allegations that it allowed customers to illegally profit by selling securities short just before public offerings of stock, regulators said.

It marks the first settlement of a Securities and Exchange Commission and NYSE Regulation Inc. case alleging that a prime brokerage firm played a role in a type of abusive short-selling practice that has prompted some companies to launch a high-profile campaign against “naked” short selling. That involves selling borrowed shares without having first borrowed the shares.

“That is an important case and it reflects our interest in this area,” SEC Chairman Christopher Cox told reporters Wednesday after a speech to the U.S. Chamber of Commerce. He declined to say if the SEC is investigating other Wall Street firms for naked short-selling abuses.

A Goldman Sachs spokesman declined to comment. Goldman Sachs Execution & Clearing LP, one of the biggest clearing firms on Wall Street and previously known as Spear, Leeds & Kellogg, settled without admitting or denying wrongdoing.

The regulators said that customers of the Jersey City, New Jersey, clearing unit made their trades through the firm’s direct access system, called REDI. Customers who were selling securities short — or selling borrowed securities in a bet on falling stock prices — had instead used the system to mark their trades “long,” regulators said, indicating that they were selling shares they owned. Customer agreements allow brokerage firms to rely on such representations.

But because the shares were not actually in the client accounts, Goldman had to lend shares to its customers in order to complete the trades, regulators said. The result was a pattern of illegal trading ahead of stock offerings from March 2000 through May 2002 that went undetected — but should have been investigated — by the brokerage firm, the SEC and NYSE said.

“A broker must have a reasonable basis to believe its customers’ representations that they own the securities they are selling,” said David Nelson, the director of the SEC’s office in Miami, in a statement.

“If, as in this case, there are significant trading disparities indicating that a customer may be lying to the broker, the broker must investigate the customer’s trading and review its trading records to determine whether it can reasonably continue to rely on the customer’s representations,” Nelson said.

For the past two years, the SEC has been focusing on abusive short selling that violates a regulation intended to prevent abuses that can occur when companies conduct secondary or follow-on stock offerings. Mostly, those cases have been brought against hedge funds or individuals, who have been accused of using improper tactics to cover short sales with stock they had purchased through such additional offerings.

Now, “this is the first case that we’ve brought against a broker,” said Teresa Verges, assistant regional director at the SEC’s Southeast regional office. She said Goldman was liable as a result of its role in executing the short sales.

The case grew out of an earlier action involving individual brokers. In 2003, brokers Ethan Weitz and Robert Altman agreed to pay more than $1 million to settle charges that they had engaged in short selling in advance of 15 stock sales. Securities rules prevent such trading on the theory that it can manipulate the prices that companies are able to generate through their stock sales. Although the two weren’t mentioned by name in the SEC’s case against Goldman, they were two of the clients who traded through the firm’s direct access system.

© 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.


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