Risk Alert Warning on Sub-accounts Trading Issued

Jack Humphrey, Regulatory journalist
September 29, 2011 /

The staff of the Securities and Exchange Commission has issued a Risk Alert warning of significant concerns regarding trading through sub-accounts, and offered suggestions to help securities industry firms address those risks.

Money laundering, insider trading, market manipulation, account intrusions, unregistered broker-dealer activity, and excessive leverage are all potential risks associated with the master/sub-account trading model, according to the alert.

Customers who open master accounts with a registered broker-dealer usually subdivide it for use by individual traders or groups of traders. In some instances, the sub-accounts may be divided to such an extent that the master account customer and the firm where the account is held might not know the identity of the traders in the sub-accounts.

“Although master/sub-account arrangements have legitimate business purposes, some customers may use them as vehicles for illegal activity, or in an attempt to avoid or minimize regulatory obligations and oversight,” said Carlo di Florio, Director of the SEC’s Office of Compliance Inspections and Examinations, whose national examination staff issued the alert.

The alert includes suggestions for broker-dealers to address concerns arising from trading in sub-accounts and to comply with the SEC’s Market Access Rule, which requires broker-dealers to have controls and procedures to limit risks associated with offering market access to customers, including those with master/sub-accounts.

“When a broker-dealer offers master/sub-accounts, this includes an obligation to reasonably design controls and procedures that address the types of risks that we identify in this report. Our national examination staff intends to scrutinize the controls and procedures at broker-dealers that offer market access to master/sub-account customers,” di Florio said.

Possible approaches include obtaining and maintaining the names of all traders authorized to trade in each master account, including all sub-account traders; verifying the identities of all such traders, using fingerprints if appropriate, background checks and interviews; and periodically checking the names of all such traders through criminal and other databases.

The SEC may also monitor trading patterns in both the master account and sub-accounts for indications of insider trading, market manipulation, or other suspicious activity; physically securing information of customer or client systems and technology; establishing requirements that validate the trader’s identity; logging and tracking incidents of attempted hacking or other unauthorized penetration-of-system by outside parties; determining that traders who have access to the broker-dealer’s trading system and technology have received training in areas relevant to their activity, including market trading rules; regularly reviewing the effectiveness of all controls and procedures around sub-account due diligence and monitoring; and creating written descriptions of all controls and procedures for sub-account due diligence and monitoring, including the frequency of reviews, the identity of those responsible for conducting such reviews, and a description of the review process.

This is the first in a continuing series of Risk Alerts that the SEC’s examination staff expects to issue.

Julius Leiman-Carbia, Robert Sollazzo, Rosanne Smith, George Kramer, Laura Magyar and John Guidroz contributed to the Risk Alert.

 

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