Risk Management Controls for Brokers or Dealers with Market Access SEC Rule 15c3-5 Risk Management Controls for Brokers or Dealers with Market Access

BACKGROUND The SEC finalized Reg. 15c3-5 in November 2010 with a compliance date of July 2011. In June 2011, the compliance date was extended to November 30, 2011 for fixed income securities. Though often talked about in relation to “naked access” or “sponsored access”, the regulation is much broader.

Who is Covered? The Regulation applies to every broker-dealer that is an exchange member, an ATS subscriber, or is an ATS operator with non-broker-dealer subscribers. The rule applies to ALL trades for customers, broker-dealers and any proprietary trades done through an Exchange or ATS. The rule does not apply to trades done outside of an Exchange or ATS, e.g., directly between broker-dealers.

Broker-Dealers must: Establish, document, and maintain a system of risk management controls and supervisory procedures that are reasonably designed to: Systematically limit the financial exposure of the broker or dealer that could arise as a result of market access, and Ensure compliance with all regulatory requirements that are applicable in connection with the market access. According to the SEC, these systems must be automated and applied pre-trade. The fundamental idea is that if there are automated trading systems, there must be automated controls.

Specifically: The system would be required to: prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous; prevent the entry of orders unless there has been compliance with all regulatory requirements that must be satisfied on a pre-order entry basis; and prevent the entry of orders that the broker-dealer or customer is restricted from trading, restrict market access technology and systems to authorized persons, assure appropriate surveillance personnel receive immediate post-trade execution reports

Review The broker-dealer is required to establish, document, and maintain a system for regularly reviewing the effectiveness of the risk management controls and supervisory procedures and for promptly addressing any issues; No less frequently than annually, conduct a review of its business activity in connection with market access to assure the overall effectiveness of such risk management controls and supervisory procedures and document that review. The CEO must annually certify that the risk management controls and supervisory procedures comply with Rule 15c3-5, and that the regular review has been conducted

Bottom Line If you trade using your MPID on an ATS for you or your client, you must have established an automated system to stop any trade in excess of credit limits. If you allow a client to use your MPID to trade on an ATS, this automated system must also apply. Your firm’s proprietary trades over an ATS are also subject to this rule as if your firm were the client.