The Securities and Exchange Commission is warning broker-dealers it will scrutinize the procedures they use to ensure they don't run afoul of the new market access rule when dealing in subaccounts used by disreputable day traders.
In a communique made on Sept. 29 entitled "National Exam Risk Alert," the SEC's Office of Compliance Inspections and Examinations says in many cases, the registered broker-dealer with subaccounts will obtain information only with respect to its customer, the owner of the master account. That means, the broker-dealer won't know who is using its market participant symbol --or MPID-- to trade. That lack of knowledge opens the broker-dealer up legal and reputational risks.
"The National Exam Program will examine for compliance with the market access rule as a means to combat violative activity in the master sub/account trading model," says the SEC. "The broker-dealer providing access will be asked to supply information regarding the nature of its risk assessment and to support its conclusions."
The new market access rule, otherwise known as Rule 15c3-5 requires broker dealers to have sufficient risk management controls and supervisory procedures in place to manage the financial, regulatory and other risks with providing a customer with access to the broker-dealer's trading systems and technology to execute orders.
In a master or sub-account trading model, a customer opens an account with a registered broker-dealer that permits the customer to have subordinate or subaccounts for different trading activities. In some instances, these subaccounts are further divided.
"Although these arrangements may be used for legitimate business purposes, some customers who seek these master/sub-account relationships often structure their account with the broker-dealer this way in an attempt to avoid or minimize regulatory obligations and oversight," says the SEC. "Promoters of these trading arrangements, who may be customers or other entities, often target potential traders in both the U.S. and abroad with promise of increased leverage and lower capital contributions than these persons would otherwise be allowed as day traders at a registered broker-dealer."
The SEC recommends that broker-dealers ensure that they obtain the names of all the traders aurhorized to trade with the broker-dealers MPID in each subaccount, verify the identities of those traders and ensure their legitimacy by checking their names through national databases, such as the Special Designated Nationals List of the Offfice of Foreign Control of the U.S. Treasury.
Among other SEC recommendations for broker-dealers:
Monitor trading patterns in both the master and subaccount levels for insider trading, market manipulation and other suspicious activity;
Track and log incidents of attempts by outside parties to penetrate systems without the proper authorization;
Ensure that traders who have access to the broker-dealer trading system and technology have received sufficient training in market trading rules and credit;
Regularly review the effectiveness of all controls and procedures around sub-account due dilgence and monitoring; and
Create written descriptions of all controls and procedures around sub-account due diligence and monitoring, including frequency of reviews, the identity of who is responsible for conducting the reviews, and a description of the review process.
-- This article first appeared on Securities Technology Monitor.
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