SEC Cautions Advisers to Address Risks of Unauthorized Trading

February 29, 2012 § Leave a comment

The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert this week to help brokerage and investment advisory firms prevent and detect unauthorized trading in their client accounts. Advisers can anticipate that the SEC and other regulators will expect to see adoption of and adherence to appropriate compliance measures to address these risks.

OCIE’s alert begins by noting that the risks of unauthorized trading are nothing new to financial firms and represent a perennial danger both to firms and their clients. Clients and firms can each suffer financial losses. Firms are also exposed to legal and regulatory penalties and reputational damage.

Firms should educate their management and non-management staff to identify unauthorized activity needing additional scrutiny. The kinds of activity identified by OCIE include:

  • changes in trading patterns,
  • high volumes of trade cancellations or corrections,
  • manual trade adjustments, or
  • unexplained profits for a particular trader or client.

Firms are instructed to adopt procedures and control functions designed to limit the ability to carry out unauthorized trading and to identify and deal with it quickly if it should occur. The specifics of those procedures and controls will depend on, and must be tailored to, the particulars of each adviser’s own business, operational and staffing circumstances. The alert briefly describes a number of controls and systems that firms should consider when preparing their own policies and procedures:

  • ensuring that those in management and supervisory roles have an understanding of the complex products and strategies employed within the firm,
  • consideration whether compensation packages are aligned with responsible risk-taking,
  • adopting open door policies to encourage early reporting of unusual or unexpected losses before they lead to greater harm to the firm and/or its clients,
  • requiring mandatory vacations without remote trading access for traders or other personnel.

At a minimum, advisers must have strong front office supervision and reporting controls to promote an overall culture of compliance. As in many other areas, the SEC is looking to ensure that “the tone from the top” is one that articulates and fosters compliance and, therefore, leads to greater protection of investors and clients. Advisers that fail to take these steps will do so at their own peril.

Sources:

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Jack G. Martel is the author of Investment Adviser Law Blog which is devoted to providing information and discussion of interest to investment advisers, private fund managers and others in the financial management industry. Jack is a partner in Ragghianti | Freitas LLP. He has over fifteen years experience in general business and securities transactions with a focus on assisting investment advisers, fund sponsors and managers in all manner of legal, regulatory and compliance issues. Jack can be reached at 415.453.9433.

 

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