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Understanding the Sec Market Access Rule

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Understanding the Sec Market Access Rule UNDERSTANDING THE SEC MARKET ACCESS RULE On November 3, 2010, the Securities and Exchange Commission (SEC) adopted the Market Access Rule 15c3-5 (MAR), which requires brokers and dealers to have risk controls for market access. The deadline to have risk controls in place for MAR compliance is July 14, 2011. WHO IS COVERED? Any broker or dealer that has market access, or that provides a customer or any other person with access to an exchange or ATS through use of its MPID or otherwise, is required to comply with MAR. [See pg. 69795] WHAT IS COVERED? All trading in all securities on an exchange or ATS, including equities, options, exchange traded funds, debt securities and security-based swaps. [See pgs. 69792, 69795, 69825] WHAT IS REQUIRED? 8. Financial and regulatory risk management controls and supervisory procedures must be under direct and ex- Any broker or dealer providing market access is required to clusive control of the broker dealer with market access establish, document, and maintain a system of risk man- other than in limited situations related to regulatory (not agement controls and supervisory procedures reasonably financial) oversight obligations designed to: 9. Must establish a system for regularly reviewing the 1. Prevent the entry of orders that exceed appropriate effectiveness of risk management controls and pre-set credit or capital thresholds supervisory procedures and promptly assessing any 2. Prevent the entry of orders that appear to be erroneous issues 3. Prevent the entry of orders unless compliant with all 10. Chief Executive Officer of the broker dealer must certify regulatory requirements that must be complied with on annually that the risk management controls and super- a pre-order basis visory procedures comply with MAR 4. Prevent the entry of orders that the broker dealer or [See pgs. 69795 and 69796] customer is restricted from trading WHAT IS CONSIDERED “MARKET ACCESS”? 5. Restrict market access technology and systems to authorized persons “Market access” is intentionally defined broadly so as to 6. Provide appropriate surveillance personnel with immedi- include not only direct market access or sponsored access ate post-execution reports services offered to customers of broker-dealers, but also access to trading for the proprietary account of the 7. Preserve a copy of supervisory procedures and written broker-dealer and for more traditional agency activities. description of risk management controls as part of books and records [See pgs. 69796, 69798] Page references are to the attached MAR Federal Register publication Vol. 75 No. 219 WHAT CONSTITUTES “REASONABLY DESIGNED” at all other market centers and that limit could not be CONTROLS, POLICIES AND PROCEDURES? increased to reflect any unused portion of credit limits at MAR allows flexibility for the details of the controls and other market centers (and presumably by analogy could not procedures to vary from broker-dealer to broker-dealer, be increased to reflect any unused portion of credit limits depending on the nature of the business and customer among disparate trading systems or classes of securities). base so long as they are “reasonably designed” to achieve [See pg. 69800] In addition, MAR adopting text reiterates the the goals articulated in the rule — the rule does not employ SEC’s expectation that broker-dealers should monitor on an a “one-size-fits-all” standard for determining compliance ongoing basis whether credit thresholds remain appropriate with the rule. [See pg. 69798] and should make prompt adjustments to credit thresholds, controls and procedures as warranted. [See pg. 69802] GOALS OF THE MARKET ACCESS RULE FLEXIBILITY TO “DISCOUNT” OPEN ORDER MAR is designed to ensure that broker-dealers appropriately EXPOSURE LIMITS control the risks associated with market access, so as not The MAR adopting text acknowledges that while reasonably to jeopardize: designed risk management controls should measure com- 1. Their own financial condition pliance based on orders entered, the credit or capital ex- 2. That of other market participants posure assigned to those orders may be discounted where appropriate to account for the likelihood of actual execution 3. Integrity of trading on security markets as demonstrated by reasonable risk management models. 4. The stability of the financial system [See pg. 69792] However, any broker-dealer relying on risk management models to discount the exposure of outstanding orders CREDIT/CAPITAL THRESHOLD CHECKS ARE REQUIRED should monitor on an ongoing basis and make appropriate MAR subsection (c)(1)(i) pertains to risk management and adjustments to its method of calculating credit or capital supervisory procedures to prevent the entry of orders that exposure as warranted. Broker-dealers providing market ac- exceed appropriate pre-set credit or capital thresholds in cess may wish to establish “early warning” mechanisms to the aggregate for each customer and the broker or dealer alert them when the applicable credit or capital threshold is and, where appropriate, more finely tuned by sector, se- being approached, so that additional steps may be taken to curity, or otherwise. [See pg. 69825] MAR subsection (c)(1) assure the threshold is not breached. (See pg. 69801] (ii) separately requires prevention of erroneous orders, by rejecting orders that exceed appropriate price or size pa- rameters, on an order-by-order basis or over a short period of time, or that indicate duplicative orders. MAR adopting text stresses the (c)(1)(i) obligations of a broker-dealer to set a reasonable aggregate credit limit for each customer. This section clarifies that if sub-limits are established for a customer at an exchange or ATS (and presumably by analogy if sub-limits are established for disparate trading systems or classes of securities), when added together they must equal the aggregate credit limit and when assessing the customer’s credit exposure at one market center, the broker-dealer must assume that the maximum credit limit has been reached by the customer Page references are to the attached MAR Federal Register publication Vol. 75 No. 219 OBLIGATION TO PROVIDE IMMEDIATE POST EXECUTION REQUIREMENT FOR CEO CERTIFICATION REPORTS TO SURVEILLANCE PERSONNEL The MAR adopting text stipulates that the senior-most MAR subsection (c)(2)(iv) requires broker-dealers to provide manager of a broker-dealer providing market access — immediate post-trade execution reports that result from specifically it’s CEO or equivalent officer — must review market access to surveillance personnel, which will identify and certify the efficacy of the controls and procedures at the applicable customer associated with each such execu- regular intervals. The SEC states that the annual certifica- tion report. The SEC believes immediate reports of execu- tion is considered an integral component of the required risk tions will provide surveillance personnel with important management and supervisory procedures and should help information about potential regulatory violations and better to assure their effectiveness, bolster broker-dealer compli- enable them to investigate report or halt suspicious or ance programs, and promote meaningful and purposeful manipulative trading activity. In addition these reports will interaction between business and compliance personnel. provide the broker-dealer with more definitive data regard- ing its financial exposure at any given time. [See pg. 69804] It should be noted that the MAR requirement for CEO certi- fication is similar to that of Section 404 of Sarbanes-Oxley USE OF THIRD PARTY TECHNOLOGY (15 U.S.C. Section 7262(a)), which requires that the annual Sarbanes Oxley issuer report must “contain an assessment A broker-dealer providing market access can use risk … of the effectiveness of the internal control structure and management tools or technology provided by a third party procedures of the issuer for financial reporting.” that is independent of the customer, so long as it has direct and exclusive control over those tools or technology and ACTUAL TEXT OF ADOPTED MARKET ACCESS performs appropriate due diligence. The independent third RULE 15C3-5 party could be another broker-dealer, an exchange or ATS, a service bureau, or other entity that is not an affiliate, and is For the actual text of adopted Market Access Rule 15c3-5, otherwise independent of the market access customer. The see page 69825 under “PART 240—GENERAL RULES AND broker-dealer cannot rely on risk management technology REGULATIONS, SECURITIES EXCHANGE ACT OF 1934.” that is designed, built, maintained or otherwise under the control of the customer or its affiliates. The SEC stipulates in the adopting text that a reasonably designed system of risk management controls and supervisory procedures should rely on technology that is developed independent of the market access customer or its affiliates. Any broker-dealer relying on technology developed by third parties should conduct reasonable due diligence, including with respect to the independence of the developer from the market access customer or its affiliates. [See pg. 69810] Page references are to the attached MAR Federal Register publication Vol. 75 No. 219 More Information For more information, visit www.ften.com or email [email protected]. © Copyright 2011, The NASDAQ OMX Group, Inc. All rights reserved. The above information relates generally to certain elements of the SEC Market Access Rule 15c3-5 (MAR), which has a compliance deadline of July 14, 2011. It is not intended, nor should it be used, as a replacement for independent legal and compliance analysis of the requirements of MAR. Q11-0981. 06-11 Monday, November 15, 2010 Part III Securities and Exchange Commission 17 CFR Part 240 Risk Management Controls for Brokers or Dealers With Market Access; Final Rule VerDate Mar<15>2010 16:31 Nov 12, 2010 Jkt 223001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\15NOR3.SGM 15NOR3 jlentini on DSKJ8SOYB1PROD with RULES3 69792 Federal Register / Vol. 75, No. 219 / Monday, November 15, 2010 / Rules and Regulations SECURITIES AND EXCHANGE broker or dealer that, based on its dealers.
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