By: Chris Montagnino, Director of Regulatory Affairs, Eventus
Recently, a broker-dealer was faced with an $850,000 fine from FINRA and a significant undertaking to hire an independent consultant for failures in the supervision of their surveillance and AML processes. The Firm did not have procedures to monitor for potentially manipulative trading, as well as procedures to detect and cause reporting of suspicious transactions to satisfy AML requirements under the Bank Secrecy Act. The Firm lacked certain controls around market access as required by SEC Rule 15c3-5. Further, the Firm did not have enough resources to handle the extent of alerts generated by their surveillance system and did not provide proper guidance for the staff charged with conducting the surveillance.
While the Firm accepted accounts based in China, Russia and Eastern Europe with active trading strategies, it did not have relevant written supervisory procedures, exception reports or tools to identify manipulative trading. The Firm eventually implemented a vendor surveillance system but still failed to detect and investigate suspicious activity. The Firm’s procedures did not describe how supervisors should utilize the exception reports or what activity should trigger further actions by supervisors. They also did not identify potential red flags indicative of manipulative trading. The Firm had many foreign accounts where trading was occurring in heavy volumes with large losses and included a high rate of cancellations. This activity often occurred in low price and low volume securities. Further, for several accounts, there were suspicious deposits into the accounts where the dollar amounts exceeded the customer’s known net worth. The Firm failed to identify this suspicious activity.
FINRA particularly noted that the Firm had over 200,000 alerts in a two-year period and only one staff member to review such alerts. A number of alerts were found to be closed without investigation and in other cases, there was a manual review of data performed which was deemed unreasonable by FINRA. Additionally, the Firm did not have any erroneous order controls that took into account individual characteristics of the security, such as average daily volume. The lack of such tailored controls resulted in a violation of SEC Rule 15c3-5.
VIP: This matter highlights a number of issues that can lead to a potential regulatory action with respect to appropriate trade surveillance/monitoring. FINRA’s Rule 3110 requires each firm to have a supervisory system that is reasonably designed to achieve compliance with securities laws and regulations relevant to the firm’s business. In particular, this includes the establishment and maintenance of written procedures. Appropriate staffing to implement the written procedures and ensuring that the procedures adequately address the risks of the specific business are critical to meeting the reasonableness standard established by the rule. In terms of surveillance, implementing a system without tailoring/calibrating the procedures to trading activity within your firm similarly impacts the reasonableness of your overall supervisory program.
In this matter, the controls around transaction monitoring exacerbated the supervisory issues as the clear red flags around low priced securities, consistent losses and large deposits went undetected by the Firm. Additionally, the market access controls for erroneous orders were not tailored to identify orders exceeding a certain size/dollar amount given the volume of the security, rendering the control potentially ineffective.
Validus maintains numerous procedures to monitor for manipulative trading. Applying robotic process automation to the procedures allows for more efficient alerting to limit the amount of false positives and more focused attention to valid alerts. Validus also offers risk checks regarding order placement and routing that provide an effective post-trade check to confirm if the Firm’s market access controls for SEC Rule 15c3-5 are functioning correctly. Firms can tailor their written supervisory procedures to reflect their calibrated parameters and evidence an effective review process. Eventus recently added Validus AML to the platform which allows clients to conduct their transaction monitoring and trade surveillance via one integrated platform. We work with our clients to calibrate their parameters appropriately for their risks so that they can develop a reasonable supervisory process to demonstrate to their regulators.
Eventus is a leading global provider of multi-asset class trade surveillance and market risk solutions. Its powerful, award-winning Validus platform is easy to deploy, customize and operate across equities, options, futures, foreign exchange (FX), fixed income and digital asset markets. Validus is proven in the most complex, high-volume and real-time environments of tier-1 banks, broker-dealers, futures commission merchants (FCMs), proprietary trading groups, market centers, buy-side institutions, energy and commodity trading firms, and regulators. The company’s rapidly growing client base relies on Validus and Eventus’ responsive support and product development teams to overcome its most pressing regulatory challenges. For more, visit www.eventus.com.