The Financial Industry Regulatory Authority (FINRA), the CBOE Holdings Company Bats, NASDAQ Stock Market LLC, and the New York Stock Exchange (NYSE) fined four firms for violating the Market Access Rule (Securities Exchange Act of 1934 Rule 15c3-5) after an investigation conducted by the Department of Market Regulation.
Rule 15c3-5 requires brokers and dealers who buy and sell shares (for customers) directly on an exchange or alternative trading system (“ATS”) to “establish, document and maintain a system of risk management controls and supervisory procedures” that “(1) systemically limit the financial exposure of the broker or dealer that could arise as a result of market access, and (2) ensure compliance with all regulatory requirements that are applicable in connection with market access.” This rule was essentially implemented to mitigate financial risks in the securities market. The SEC notes that “Rule 15c3-5 is designed to ensure that broker dealers appropriately control the risks associated with market access, so as not to jeopardize their own financial condition, that of other market participants, the integrity of trading on the securities markets, and the stability of the financial system.” Preventing market access to manipulative traders is paramount in maintaining a fair and efficient market that sets out to protect investors.
The four companies charged with violating the provisions of Rule 15c3-5 from May to July 2017 include Deutsche Bank (fined $2.5 million), Citigroup (fined $1 million), J.P. Morgan (fined $800,000), and Interactive Brokers (fined $450,000). They permitted market access to clients who bought and sold millions of shares daily and failed to prevent and detect manipulative trading activity on the market and enforce the provisions of the Market Access Rule. The companies were found to be in violation of the financial risk management controls and supervisory procedures (Rule 15c3-5(c)(1)) such as, preventing orders that exceed appropriate pre-set credit or capital thresholds (Rule 15c3-5(c)(1)(i)) and preventing the entry of erroneous or duplicative orders (Rule 15c3-5(c)(1)(ii)).
How can broker/dealer firms mitigate the risk of breaching the provisions in the Market Access Rule? Ensure that your firm is complying with the measures by implementing a clear risk management system to prevent issues such as duplicative orders. Broker/dealers may use technology provided by an exchange or ATS for regulatory risk management if they meet the requirements of the Rule, however, the technology must be under the “exclusive control” of the broker/dealer. Rule 15c3-5 applies to all securities and futures, but not future contracts or options on future contracts (therefore all broker/dealers subject to the Rule must follow these risk measures). When determining whether traders are exceeding the appropriate pre-set credit or capital thresholds, the SEC advises broker/dealers to “exercise reasonable business judgment” by ascertaining when levels of trading become erroneous. Broker/dealers should exercise their due diligence when assessing a customer’s financial situation and trading patterns (this information should be regularly monitored). When erroneous trading is detected, it is important to notify the SEC immediately.
The SEC has provided a helpful FAQs relating to the details of Rule 15c3-5 and when it applies.