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Firm Offered Market Access But Lacked Risk Management Controls
by Howard Haykin
As both a broker-dealer with market access and a provider of market access to customers this firm was required to comply with SEA Rule 15c3-5 which, among other things, called for the firm to establish, document, and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory, and other risks of this business activity.
SEA Rule 15c3-5(c)(2) states that a firm's regulatory risk management controls and supervisory procedures shall be reasonably designed to ensure compliance with all regulatory requirements, including:
- prevent the entry of orders unless there has been compliance with all regulatory requirements that must be satisfied on a pre-order entry basis;
- prevent the entry of orders for securities for a broker or dealer, customer, or other person if such person is restricted from trading those securities;
- restrict access to trading systems and technology that provide market access to persons and accounts pre-approved and authorized by the broker or dealer; and
- assure that the appropriate surveillance personnel receive immediate post-trade execution reports that result from market access.
And because it dealt with municipal securities, the firm was further required to comply with MSRB Rule G-27(a), which required the firm to supervise the conduct of its municipal securities activities and to ensure compliance with MSRB Rules and the Securities Exchange Act of 1934 – including the establishment and maintenance of written procedures.
WHAT WENT WRONG. From August 2014 through January 2017, the firm failed to establish, document, and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory, and other risks of this business activity.
With regard to both its own trading on the external ATSs and its subscriber client trading on Clarity BidRate, … the firm failed to systematically limit the financial exposure of the broker or dealer that could arise as a result of market access, including being designed to:
- prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds in the aggregate for each customer and the broker or dealer, and to reject orders if such orders would exceed the applicable credit or capital thresholds;
- prevent the entry of erroneous orders, by rejecting orders that exceed appropriate price or size parameters, on an order by order basis or over a short period of time, or that include duplicative orders.
With regard to the firm's trading on the external ATSs, … the firm failed to establish, document, and maintain its own financial risk management controls, including those designed to:
- prevent the entry of orders that exceeded pre-set capital thresholds, and to systemically limit the aggregate financial exposure resulting from market access across different external ATSs.
Under these circumstances, the firm's reliance on the external ATS controls did not function to meet the firm's obligation to establish, document, and maintain reasonably designed financial risk management controls.
This case was reported in FINRA Disciplinary Actions for May 2019.
For further details, click on... FINRA AWC #2017052227601.
