Tone the Risk Down: Outsourcing Middle & Back Office Processes as a Preventive Approach
The risk for broker dealer noncompliance (in the eyes of the SEC and FINRA) has always been high, but the SEC’s recent decision to finally curtail their “neither admit nor deny” policy in refusing to settle with Reserve Primary Fund sets potential risk even higher. This signals that firms who run afoul of SEC regulations may not only face monetary penalties, but criminal charges as well. Even powerful financial institutions that were previously able to escape criminal penalties through settlements, like Bank of America, Goldman Sachs, and JPMorgan Chase, are now vulnerable to criminal charges.
Combined with the already fluctuating broker dealers regulatory landscape, this change puts renewed emphasis on ensuring compliance throughout your firm. Keeping your firm out of the regulatory limelight starts with tempering risk. Thanks to the rise of third party, automated solutions, capital markets organizations have options when it comes to taming the threats that frequently invade their middle and back offices.
A Reasonable Standard
For functions like trade monitoring and compliance, broker dealers are on the hook for tracking all orders and executions submitted by multiple clients – any missed red flag could result in a failed FINRA audit, fines or lengthy litigation. Automated third party systems are designed to prevent these breaches from occurring, and catch violations that do slip through before they become catastrophic.
The same can be said of outsourcing commission sharing agreements (CSAs), billing and other middle office services. While CSAs represent a critical component of operations for buy-side firms, managing soft dollars to perform in-house research places additional risk on your business, especially given the SEC’s stringent reporting and compliance requirements. Relying on a half-baked, in-house technology or compliance tool for these tasks only increases your firm’s margin of error. A more cautious alternative? Adopting a program developed by an external provider, whose sole focus is creating the robust, secure technology to automate these processes.
Billing mishaps, too, have the potential to create immense legal and financial difficulties for your firm – refusing to modernize the task from a manual or one-person job could open the door for more vulnerabilities.
Migrating to licensed technologies helps firms ultimately fulfill certain SEC and FINRA mandates. Even a casual glance at most regulations reveals a preponderance of one word: “reasonable.” Firms are required to take reasonable precautions, make reasonable efforts at ensuring compliance, be reasonably transparent with their clients, and so on. Importantly, firms are not expected to be perfect, but they are expected to make a serious effort at ensuring compliance.
Better to be Prepared
Even when regulatory infractions cannot be prevented, the ability to show that sufficient compliance controls were in place within your operation can serve to dramatically reduce or eliminate culpability in the event of a breach. If a firm failed to catch a trade violation or manipulation due in part to negligence or malicious intent, it would likely face repercussions, though not as severe as those that would be administered to firms with no compliance strategy in place. The SEC is even advising firms to tout their compliance programs to prove that they’re proactively meeting the industry’s “reasonable” supervision standards.
Given the SEC’s aggressive push to hold erring firms accountable criminally as well as financially, the risks of noncompliance are greater than ever. Putting any compliance procedure in place is better than nothing, but turning to tools built by specialists – specialists who sit at the intersection of the capital markets, industry regulation and technology – can have a dramatic effect on the risk level within your business. In today’s changing and uncertain market, automated tools may be firms’ best bet against reputational backlash and SEC charges, criminal or otherwise.