Broker Dealers That Got Market Surveillance Wrong and Are No Longer In Business as a Result

Broker dealers operate in one of the most tightly regulated industries in the U.S. The shifting legislative landscape leaves many firms and investors searching for ways to maintain or increase revenue while complying with SEC and FINRA regulations.

Small brokerage firms – some employing only two or three individuals – have struggled to weigh the risks of investing in software solutions and extra staff members versus praying they don’t get caught. But for some small broker dealers there shouldn’t be a discussion. Noncompliance from a lack of software or manpower can bring business to a halt.

Broker Dealer Consolidation

While many large broker dealers have invested in new technology that effectively replaces the manual processes historically relied on by compliance officers, others aren’t able to keep up. As a result, the broker dealer market has seen consolidation as small to mid-sized brokerages had to choose between shuttering or merging in the face of a growing cost base.

According to a research report by the Compliance Department Inc., the number of registered broker-dealers fell nearly 10 percent between 2007 and 2012, and multiple sources estimate the population will continue to trend downward.

That’s not an anomaly when you consider the enormous regulatory pressures exerted in the wake of the financial crisis. And while trading volume has recovered, there aren’t as many firms executing those trades. Compliance costs have clearly led to more consolidations.

While the bigger firms can afford to dedicate some of their revenues to updating compliance software and training personnel, smaller firms don’t have the money to reinvest in proper monitoring equipment.

One Employee Can Bring Down the Whole Firm

Although most compliance issues involve manipulative practices and poor decisions by a firm’s executives, in some cases, only one or two employees can shut down the entire firm.

With employees executing hundreds or thousands of trades per day, one or two employees can add a mountain of regulatory work.

That makes surveillance a complex problem. Look at air travel security.  The TSA is looking for a handful of bad actors among 1.5 million air travelers in the U.S. each day. Trading surveillance has similar problems at scale.

Last April, the SEC charged a former broker with scheming to personally profit from unauthorized orders of Apple stock. When his scheme backfired, it ultimately caused his Connecticut-based brokerage firm, Rochdale Securities LLC, to cease operations.

The former broker, David Miller, an institutional sales trader from Rockville Centre, New York, agreed to a partial settlement of the SEC’s charges and pleaded guilty in a parallel criminal case.

The SEC alleges that Miller misrepresented to Rochdale Securities LLC that a customer had authorized the Apple orders. The customer ordered 1,625 shares of Apple stock, but Miller instead entered an order of 1.625 million shares at a cost of nearly $1 billion.

If Apple’s stock jumped, Miller planned to share in the customer’s profit. If the stock declined, he would’ve claimed to have made a mistake entering the order. The stock value decreased and Rochdale was forced to cease operations to cover the losses Miller accumulated for the firm.

Cases like these illustrate the benefit and critical nature of compliance monitoring software, no matter what size the business. If brokerage firms like Rochdale had invested in the right technology, they could have prevented such losses from happening – demonstrating the true cost of failing to comply with financial regulations.

Embracing automated compliance solutions is a broker dealer’s first step in establishing credibility with their clients, and guaranteeing long-term business stability.