The Securities and Exchange Commission voted Wednesday to adopt a rule that requires broker-dealers to establish "risk controls" before providing their customers with market access.
Broker-dealers can electronically access an exchange or alternative trading system (ATS) with a market participant identifier. Under the new rule, BDs will be prohibited from allowing customers "naked access" to an exchange or ATS using the BD's identifier.
When customers access the exchange without going through their BD, the SEC claims there is an "increased likelihood" that the customer will enter incorrect orders, either as a result of computer malfunction or simple human error; that customers will fail to comply with regulatory requirements; or that customers will breach a credit or capital limit.
"In addition, the inter-connectedness of the financial markets can exacerbate market movements, whether they are in response to actual market sentiment or trading errors," the SEC noted in a statement announcing the rule.
Chairman Mary Schapiro (left) compared the practice with "giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied."
“This rule requires that broker-dealers not only remain in the car, but also maintain control of it so we can all be assured the rules of the road will be observed before the car is ever put into drive,” she said in a statement.
The SEC is particularly concerned that the risk controls BDs put in place will be ineffective, or will rely on a customer's promise that controls are in place.
The new rule will be effective 60 days from the date of its publication in the Federal Register, according to the SEC, and BDs will have six months to comply.
The rule will apply to broker-dealers who are members of an exchange or subscribe to an ATS, as well as to BD operators that provide access to trading securities on their ATS to someone other than a BD.
As part of the rule, broker-dealers would be required to:
- Create financial risk management controls reasonably designed to prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous.
- Create regulatory risk management controls reasonably designed to ensure compliance with all regulatory requirements applicable in connection with market access.
- Have certain financial and regulatory risk management controls applied automatically on a pre-trade basis before orders route to an exchange or ATS
- Maintain risk management controls and supervisory procedures under the direct and exclusive control of the broker-dealer with market access. There would, however, be limited exceptions, as specified in the rule, to permit a broker or dealer to reasonably allocate certain controls and procedures to another registered broker or dealer that, based on its position in the transaction and its relationship with the ultimate customer, can more effectively implement them.
- Establish, document and maintain a system for regularly reviewing the effectiveness of its risk management controls and for promptly addressing any issues.