Senior ranking brokerage operations and operational risk executives beware: the Securities and Exchange Commission now says that the buck stops with you, when it comes to proving you have sound procedures in place.
“The SEC can’t delve into every business line at the brokerage firm so it is looking to get a more holistic view of operations before it focuses on specific units, says Loren Schechter, a partner in the New York office of law firm Duane Morris. “That means senior level executives will be nailed for any regulatory errors.”
Funding increases for the SEC and the Commodity Futures Trading Commission, agencies responsible for rulemaking under the financial regulation overhaul enacted in 2010 are being held up by Congress. SEC Enforcement Director Robert Khuzami has said that his unit has postponed technology upgrades and hiring over concerns that it won’t get the funding it needs.
On February 8, Carlo di Florio, the SEC’s Director of the Office of Compliance Inspections and Examinations provided some inkling of the SEC’s newfound direction.
He said his office will review enterprisewide risk including how business units manage risk and whether” risk management, control and compliance are embedded into the business processes of the brokerage firm.”
“While the SEC has sporadically cited the need for broker-dealers to address enterprise-wide risk the presentation by di Florio offers better insight into the types of questions which broker-dealers will be asked to address durng exams.,” says Edward Pittman, counsel in the Washington, DC office of Dechert LLP. “One area they may inquire about is the firm’s procedures for how material operational errors are elevated to senior management.”
Di Florio’s stance appears to have been exemplified in the case of quantitative fund manager Axa Rosenberg, who on February 3 agreed to pay a whopping $242 million for a coding error in its risk model. Of the $242 million, $217 million was to cover investor losses and $25 million was for a civil penalty. The SEC’s beef: although the error was discovered in June 2009, senior management did not learn about it until it was being fixed in the “fall of 2009.”
The SEC’s Office of Compliance Inspections and Examinations was not notified of the error until March 2010 and AXA’s clients – some of the world’s largest pension plans—were told a month later. In addition, when the error was initially discovered the clients had been told that the underperformance of their portfolios resulted from market volatility and other factors.
Schechter recommends firms with large trading operations focus on whether they can meet best execution practices and document their procedures for algorithmic trading, high frequency trading and sponsored access. For retail firms, the focus should be on appropriate customer disclosures, he says.
Third-party processing firms, namely correspondent clearing firms, should concentrate on appropriate protection of customer assets and computer glitches. Those recommendations appear to be the same issues that the Financial Industry Regulatory Agency has said it will tackle in its exams of broker- dealers this year.
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