SEC Charges Against Wedbush Securites Raise Issues With Direct Risk Controls
Monitoring third-party platforms
In Wedbush’s case, the SEC is asserting that the broker must have “direct and exclusive control of the risk checks” to ensure they are enforced without someone modifying them other than the broker dealer.
It also appears that Wedbush’s problem stemmed from customers who used their own proprietary systems or third-party systems that are leased from service bureaus.
“If the system that the traders are using is a third-party system from outside the particular broker dealer, then the broker-dealer would have to engage with the third-party system to make sure they have the direct control over those risk checks,” said Masso.
“They need to document those changes for the risk checks and they really need to have a good surveillance platform in place so that the third-party system is feeding an internal system with in the broker-dealer.” This is so that the broker dealer can supervise the traders and make sure, on an ongoing basis, those checks are being enforced, he said.
“There needs to be an integration between the broker-dealer and those third-party systems, and without that, you don’t have any independent verification.”
Wedbush began providing “sponsored” market access to customer firms in 2004, which allowed customer firms and their traders to send orders that bypassed Wedbush’s trading systems and were routed directly to exchanges and other trading venues through Wedbush’s market participant identifier (MPID). Sponsored-access customers used online trading platforms or software platforms that the customer either owned directly or leased from a third-party platform, known as a service bureau.
Wedbush’s clearing business had about 50 sponsored-access customers that generated average monthly trading volume of 30 billion shares, according to the SEC administrative order. Some of the sponsored-access firms had more than 1,000 authorized traders each, and one had more than 10,000 trades. In June 2011, Wedbush acquired Lime brokerage, after which, about 20 percent of the sponsored-access firms used Lime’s platform. But Wedbush did not directly set or monitor regulatory risk settings in the third party or client-proprietary trading platforms that 80% of the firm’s customers used.
Broker needs direct control of risk settings
According to the SEC, Wedbush employees in the correspondent services division received access from platform providers to view risk settings and trading activity in the platforms, but the firm did not have exclusive control over the settings. “Wedbush continued to allow sponsored access customers to determine and make changes to the risk settings in the platforms,” according to the SEC order. Sponsored access customers performed initial “risk demonstrations” to show Wedbush the customer’s trading platform settings for certain risk controls, stated the order.
Wedbush had a checklist for the risk demonstration that included settings to prevent clearly erroneous trades, wash trades, illegal short sales, and intermarket sweep orders. However, the fact that Wedbush needed the customer to show the settings demonstrates that Wedbush did not have “direct and exclusive control” over the risk settings in the platforms, which is required by the Market Access Rule, stated the SEC’s order.
As a result of market access trading by its customers, the SEC said, Wedbush had other violations, including Regulation SHO related to short sales, and Regulation NMS related to intermarket sweep orders and two more rules related to anti-money launching requirements and preservation of records.
To avoid violations, Masso said it’s important to have an automated surveillance process for any system that is connected to the market. They would want to have checks for Reg SHO for shorts and for wash sales in individual accounts.
Also, the SEC wants to see the broker take direct control of loading the short lists. In terms of Reg SHO, Wedbush relied on sponsored-access customers or the platform provider to load the list of “easy to borrow securities” on to the third-party trading platforms rather than ensure that customers were using the correct list. According to the SEC, the accuracy of the lists will determine whether the platform is in compliance.
“When a broker dealer uses a third-party system they really need to look at the process within the system, that checks are in place and that checks are set by the broker dealer, and not the customer,” said Masso.
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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