supervision

Exam Alert: SEC clarifies supervisory liabilities of legal and compliance personnel

On September 30, 2013, the Division of Trading and Markets of the SEC put out an FAQ detailing when legal and compliance personnel would or would not be held responsible for failing to supervise a broker-dealer employee that commits a violation. Legal and compliance personnel are not, by default, considered supervisors, so they are not held responsible unless their position places them in a supervisory role. This can be determined by considering whether the personnel has the “requisite degree of responsibility, ability or authority to affect the conduct of another employee.” The Division lists several questions that can be used to ascertain whether the personnel has such responsibility, ability, or authority, but key elements are:

whether the company is structured in such a way that the personnel is clearly designated with responsibility,
whether the personnel can hire, reward, punish, or fire the employee, and
whether the personnel knew or should have known that he or she was responsible for preventing the violation.

Source: Frequently Asked Questions about Liability of Compliance and Legal Personnel at Broker-Dealers under Sections 15(b)(4) and 15(b)(6) of the Exchange Act

Further reading: United States: When Legal Or Compliance Personnel May Be Subject To Failure To Supervise Liability Under The Securities Laws

This alert applies to the Series 24, Series 26, Series 62, and Series 82.

Exam Alert: SEC identifies concerns, good practices regarding nonpublic information

On September 27, 2012, the SEC identified situations ripe for abuse of inside information at broker-dealers so that industry professionals will know what to avoid. The SEC also provided examples of good policies put in place at some broker-dealers that minimize the risk of insider trading violations. Continue reading

Potentially problematic situations include the following:

-Lots of informal, undocumented interaction between departments with MNPI (material nonpublic information) and sales/trading departments that could abuse that information

-Having senior executives that supervise multiple departments and could spread MNPI from one department to another without oversight, due to being “above” the information barriers

-Lack of review of situations where MNPI is provided from one department to another for business purposes

-Lack of review of trading in customer and affiliate accounts

-Lack of review of situations where MNPI is received from an outside source

Effective practices included:

-Having a system that distinguishes MNPI based on source or type of information (possibly even having individualized reports specific to certain pieces of information)

-Expanded review of potential misuse of MNPI, including looking at trading in swaps, loans, components of pooled securities (such as UITs and ETFs), warrants, and bond options

-Monitoring access to electronic sources of MNPI to see which employees access the information

-Monitoring access levels granted via key cards and computer networks to ensure that only authorized personnel have access to restricted areas

Source: SEC Issues Report on Brokerage Firms’ Handling of Confidential Information (SEC Release 2012-200)

This alert applies to the Series 24, Series 26, Series 6, Series 7, Series 55, Series 62, Series 79, Series 82, Series 99, Series 63, Series 65, Series 66, and Series 56.

Exam Alert: SEC identifies good due diligence practices for municipal securities underwriters

On March 19, 2012, the SEC staff released a risk alert that reminds firms acting as underwriters for municipal securities of their due diligence and supervisory obligations under current rules. The alert then identifies specific examples of effective due diligence practices. Continue reading

-Clear explanation of regulatory requirements and firms’ expectations: detailed written policies and procedures that make clear how to conduct due diligence and include relevant rules and guidance

-Commitment committees: firm-wide, senior level committees that provide an additional step of review for various underwritings

-Diligence checklists: checklists to record which due diligence steps have been taken

-Due diligence memoranda: memos prepared by public finance bankers that describe any due diligence concerns and provide a review of the final official statement

-Outlines for due diligence calls: outlines prepared by underwriters’ counsel or issuer’s counsel that address disclosure concerns identified during due diligence calls

-On-site examination activities: on-site examinations to check the issuer’s fiscal prospects

-Recordkeeping checklists: checklists to make sure records of due diligence activities are made and properly stored

Source: SEC Release 2012-48

This alert applies to the Series 7, Series 79, Series 24, and Series 62.

Exam Alert: SEC releases risk alert on unauthorized trading

On February 27, 2012, the SEC released a risk alert providing suggestions for techniques and controls a firm may use to help avoid conducting unauthorized trades. The alert has a large focus on supervisory procedures, but also addresses other ways in which firms can make it harder for employees to engage in unauthorized trading. The alert identifies alternative methods to more readily detect unusual trading activity and stresses the importance of a culture of openness and compliance. Continue reading

Suggestions for supervisory procedures include:

-Have more than one chain of control be responsible for monitoring the integrity of the business, i.e. don’t have all your compliance personnel report to the same person.

-Managers and supervisors should understand any complex products and strategies being employed by traders.

-Supervisors should engage in discussions with traders and portfolio managers and address positions that are unusual (given the strategies and/or client objectives involved).

-Make sure the payment structure for traders and supervisors encourages responsible risk-taking.

-Try to avoid having one person or desk fulfill multiple roles.

-Have an “open-door” policy that encourages traders to report unexpected losses promptly.

-Limit trader access to their appropriate portfolios – don’t let them keep access to ones that they are no longer authorized to trade in.

-Consider additional controls (several are listed in the alert).

Other suggestions include:

-When an employee transfers into the trading department, remove any prior system access he or she had.

-Have controls in place to confirm extended settlement trades and rollovers.

-Review delays and discrepancies in the customer trade confirmation process to check for unauthorized trading.

-Require mandatory vacations for traders with no remote access to accounts, then assign their portfolio(s) to a supervisor or experienced trader for the duration. Use this time to check for unusual activity.

-Have the audit and compliance departments review trading strategies, business performance, and risk profile.

-If the firm has multiple recordkeeping systems, try to integrate them.

-Test the controls put in place to discourage unauthorized trading.

-Maintain a corporate culture of honesty, integrity, accountability, and responsible risk-taking.

Source: SEC Release 2012-33

This exam alert applies to the Series 24, Series 26, Series 6, Series 7, Series 62, Series 79, Series 82, and Series 99.

Exam Alert: FINRA recommends heightened supervision for complex products

On January 17, 2012, FINRA highlighted the need for firms to have adequate supervisory and compliance programs in place in order for registered representatives to recommend complex products. FINRA identified several characteristics that may cause a product to be considered “complex,” such as embedded derivatives or contingencies. The notice states that agents should determine suitability, consider the customer’s financial sophistication, discuss the products with the customer, and consider alternative investments that could meet the customer’s goals. The firm should also review the performance of the products and train the agents about the products. Continue reading

Source: FINRA Regulatory Notice 12-03

This alert applies to the Series 6, Series 7, Series 24, Series 26, Series 55, Series 62, Series 79, Series 82, Series 99, Series 63, Series 65, and Series 66.

Exam Alert: Proposed FINRA rule will clarify firms’ supervisory responsibilities for outsourced activities

On March 29, 2011, FINRA requested comment on proposed FINRA Rule 3190. The proposed rule makes it clear that when a firm outsources a function or Continue reading

On March 29, 2011, FINRA requested comment on proposed FINRA Rule 3190. The proposed rule makes it clear that when a firm outsources a function or activity to a third party, the firm is still responsible for complying with applicable securities law and FINRA and MSRB rules. This responsibility cannot be delegated to another party. Firms will also be required to have supervisory procedures in place to ensure compliance with the rule.

http://www.finra.org/Industry/Regulation/Notices/2011/P123399