A Timeline of the Evolving Compliance Landscape: New Regulations That Will Affect Broker Dealers

As part of its commitment to avoiding another financial crisis, the SEC is demanding that broker dealers make new investments in trading surveillance. To do that, the SEC and FINRA are tacking on new requirements that will push broker dealers to add new compliance tools to their repertoires.

Earlier this year, Direct Edge, the third largest stock exchange operator in the U.S., agreed to allow FINRA to manage the surveillance of all trading activity on its two licensed stock exchanges. This close partnering of exchange and regulatory body means that 90 percent of all trading volume on U.S. exchanges is actively overseen by FINRA.

The agreement, allowing FINRA a nearly complete view of activity across multiple equities markets, affords regulatory bodies a clearer picture into trading activity than ever before. Such close monitoring of the capital markets industry will heavily impact broker dealers.

SEC Introduces a Consolidated Audit Trail Requirement

Although electronic trading has allowed traders access to dozens of exchanges, that fractured environment makes it difficult to piece together trading activity from start to finish. Last July, the SEC voted to require FINRA and the exchanges to establish a consolidated audit trail that would allows regulators to monitor trading activities more completely.

The new rule calls for the exchanges and FINRA to jointly submit a plan detailing how they would develop, implement and maintain a consolidated audit trail that collects and accurately identifies every trading action for all market-wide equities.

The audit trail, which will assist regulators in their investigations of insider trading and subtler market manipulation, was established because there is no preexisting database that stores such information.

SEC Makes Amendments to Financial Responsibility Rules

Last month, the SEC announced several amendments to the financial responsibility rules for broker dealers to better protect customers and enhance the SEC’s ability to monitor and prevent unsound business practices.

The SEC made amendments to four rules:

  • Net Capital Rule. Changes to this rule will require a broker dealer to include any liabilities that are assumed by a third party in its net capital calculation. That rule is meant to ensure derivative positions are transparent.
  • Customer Protection Rule. The amendment will reconcile two different definitions of “customer” in Rule 15c3-3 of the Securities Exchange Act of 1934 (which doesn’t include broker dealers) and the Securities Investor Protection Act (which includes broker dealers) by requiring “carrying broker dealers” that maintain customer securities and funds to have a new segregated reserve account for account holders that are broker dealers.
  • Books and Records Rules. Amendments to these rules will require large broker dealers to document their market, credit and liquidity risk management controls.
  • Notification Rule. These amendments will establish new notification requirements when a broker dealer’s repurchases and securities lending activities surpass a certain level, and mandate that a broker dealer may submit monthly stock loan and repurchasing activity reports to its designated examining authority.

SEC Requires Quarterly Form Custody Reports

Under these new amendments to SEC rules, brokers must now file quarterly “Form Custody” reports, detailing to the SEC whether and how they maintain control of their clients’ funds; this standard becomes effective at the end of 2013.

Currently, a broker files an annual report about client assets over which it has custody, including audited financial statements from an independent public accountant. This new requirement means the SEC or FINRA can now request to review the accountants’ work papers as well.

Additionally, if broker dealers have agency over a client’s assets, they’ll have to file compliance reports with the SEC to show that they’re meeting capital requirements, protecting the assets and properly sending customer account statements.

The SEC is making strides to protect investors; in many cases, this means more time and paperwork spent on careful monitoring for broker dealer firms. As regulatory compliance becomes more critical, broker dealers will require additional support. Broker dealers who stay one step ahead of the latest rules and make compliance a priority across their business will not only avoid the penalties and pressure of regulatory violation, but also stay resilient in the face of a fluctuating industry.