A growing fog of regulation is blurring the line that separates the compliance responsibilities of broker-dealers from those of their clearing firms.
“One of the biggest problems we have is establishing the delineation of responsibility between the two,” said Corwin Wyatt, director of compliance and trading at Pershing LLC.
With a host of new regulations in the works, the question of who needs to do what promises to grow even thornier.
Updated anti-money-laundering regulations, pending trade-reporting rules and new custody rules for advisers are some of the initiatives that are raising questions about the division of compliance responsibilities.
“Some of those lines [of responsibility have] blurred as regulators focus on anti-money-laundering,” said Jeff Horowitz, director of compliance at Pershing. “Anti-money-laundering has morphed into anything to do with fraud, manipulation or low-priced securities.”
The Treasury Department has said that “AML is a responsibility of everybody,” according to Dennis Ferguson, president of Sterne Agee Clearing Inc. That means clearing firms and correspondents can't specify or allocate their responsibilities, he said.
Know-your-customer responsibilities lie with the introducing firm, Mr. Horowitz said, but clearing firms and their B-D correspondents both have a responsibility to report suspicious activity.
The Office of Foreign Assets Control, for example, which is responsible for enforcing trade sanctions and monitoring money flows to suspected terrorists and drug dealers, does not allow financial firms to delegate compliance with OFAC rules, Mr. Horowitz added.
It's a challenge for the industry because AML rules are vague, Mr. Ferguson said. “You don't know if you're in compliance or not.”
The
Financial Industry Regulatory Authority Inc. in particular has been cracking down on transactions in unregistered low-priced stocks, observers said. The goal is to head off pump-and-dump schemes as well as potential money laundering.
In January 2009, Finra issued Regulatory Notice 09-05, warning firms about accepting large blocks of unregistered securities in certificate form. As a result, most clearing firms are refusing to accept certificates of these cheap, private securities.
In addition, last summer, Finra fined J.P. Turner & Co. LLC, Park Financial Group Inc. and Legent Clearing LLC for failing to implement adequate AML compliance programs, including the failure to report suspicious transactions in low-priced stocks.
FLASH CRASH RESPONSE
Separately, the Securities and Exchange Commission is hard at work developing new trade-reporting requirements.
The May 6 “flash crash” was an impetus to those efforts, and observers said the resulting new requirements will put yet more burdens on both clearing firms and broker-dealers.
In April, in an effort to compile more data on the major players in the market, the SEC proposed a new reporting system for large traders.
After the flash crash, the agency made a much bolder proposal — a consolidated-audit-trail system. No consolidated audit trail across multiple trading centers exists, making analysis of market drops difficult.
The large-trader system would be an interim fix pending the implementation of consolidated audit trails, said Jesse Lawrence, director of legal and trading at Pershing.
Under the large-trader proposal, broker-dealers would collect and transmit their trading data to their clearing firm, Mr. Lawrence said, and in turn, a clearing firm would have to submit the data to regulators upon request.
The new reporting regimes would come on top of the existing order audit trail system, known as OATS, which has given dealers headaches ever since it was introduced in 1998 following the Nasdaq pricing collusion scandal.
Clearing firms are responsible for transmitting their correspondents' OATS data to Finra.
“I've got to make sure my [OATS] report, [which has] lots of possibilities for unintended omissions, [is complete], but the introducing firm has a subsequent obligation to remedy incorrect submissions,” Mr. Ferguson said.
The new custody rules for investment advisers, which went into effect in March, have forced clearing firms to go back to their custody clients and rehash some of their shared responsibilities.
The rules impose more-stringent custody definitions and require advisers to hire an independent auditor to conduct surprise exams on accounts that the adviser controls.
Advisers who also have an affiliated broker-dealer and some securities accounts have been re-evaluating their clearing agreements in the wake of the custody rule, said Craig Gordon, director of RBC Correspondent Services.
Brokerage firms often have more control over client assets than RIA firms, he said, such as the ability to make address changes.
“We've been working with a number of firms to make sure our agreements specifically state the areas we're responsible for so that we make sure the introducing firm doesn't have control over assets,” Mr. Gordon said.
NEW COST BASIS RULES
Broker-dealers also have to coordinate with their clearing firms new cost-basis-reporting requirements, which will be phased in starting next year, said Bobbi Masiello, executive vice president in charge of relationship management at National Financial Services LLC, Fidelity's clearing arm.
Broker-dealers should ensure that their
portfolio management software vendor is compliant and that cost basis data on their outside portfolio system is consistent with what their clearing firms report, she said.
And finally, there's financial reform. The legislation has a mountain of new requirements for most industry participants.
Of particular importance is how any uniform fiduciary standard of care might play out and how that might affect client communications, for example.
“We do provide point-of-sale communications, and those [might] have to be updated,” Ms. Masiello said.
E-mail Dan Jamieson at [email protected].
