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Securities Police Go High-Tech

NYSE Regulation is arming its examiners with tools to identify risk at member firms, brokers and branches.

When NYSE Regulation sends a team of examiners into the field to review a member firm's financial operations or sales practices, the securities police are wired into the exchange's vast databases and regulatory systems. Today's NYSE examiners are high-tech road warriors armed with laptops, scanners and wireless cards who can remotely plug into the NYSE's Member Firm Regulation (MFR) Portal - an intranet-based set of applications.

Through the new MFR Portal, examiners can query vast databases about member firms' financial operations, customer complaints, disciplinary actions and other disclosures that point to risk, explains Angela Posillico, senior vice president, corporate and regulatory systems at NYSE Regulation. The independent regulatory division of the New York Stock Exchange was approved in December 2003, after changes were made to the NYSE's corporate governance structure. "It's bidirectional communication," she says. "This portal provides the decision support, it allows increased connectivity and it allows examiners throughout the world to keep in touch with headquarters."

Yet, NYSE Regulation's technology push may be the best-kept secret on Wall Street. Over the past few years, the self-regulatory organization has been expanding and improving its intranet-based capabilities to make information and analytical tools electronically available to examiners.

The NYSE identified the need for enhanced support technology in October 2004, particularly the need to provide examiners with access to the NYSE's intranet, eNYSE.com. Examiners could not simply use a member firm's network to connect to eNYSE.com because of security concerns, notes Posillico.

A pilot was launched in January 2005, and the first applications were made available to about 10 or 15 examiners. Currently, the goal is to roll out the hardware and access to the portal to all 175 NYSE examiners by year-end - plus another 25 exam directors, in-house surveillance staff and their coordinators, according to Posillico.

Working Smarter

In August, MFR equipped examiners with portable scanners to scan printed documents or work papers that they collect during the exam. Instead of picking up the phone or faxing or e-mailing documents from the field, on-site examiners now can submit documents as the exam unfolds, allowing exam directors - who are based in the home office - to monitor the exam while it's in progress.

"These are largely productivity tools," says Jeffrey Abramczyk, principal consultant at financial services technology consultant Capco, who specializes in audit, risk management and compliance. Some of the major public accounting firms, he notes, are using similar technologies, including imaging, to manage their audits. "If you are supervising larger firms, there's a lot of data you have to gather, so leveraging computer technology has to help," asserts Abramczyk.

According to Sheila Haney, examination director in the sales practice review unit of MFR, the technology vastly improves communication. "When you have 97 percent of the team in the field at all times, it's very hard to communicate," she says.

Haney explains that the exam director is responsible for the content and execution of the examination. "The big challenge is [identifying] who's where," she adds, noting that a team of six can be spread across the country and as far away as Uruguay. Adding to the challenge, the exam director is responsible for multiple exams at one time. "That's how the whole theme of the portal came about," Haney notes. Now, examiners are able to plan the scope of their examinations better, scan in documents and collaborate with the rest of the team remotely, she adds.

Before leaving the home office, the exam director can select from an overall scope of 1,400 questions to tailor the exam to a specific firm. On the road, an application that resides on the laptop - called Answering Scope Kit, or ASK - is used to guide the on-site examiner through the questions to be asked.

Prior to the portal, "The examiner would have to go out with massive spreadsheets and books to reference the NYSE rules," relates Thomas McNally, managing director, regulatory and corporate systems, NYSE. Now that all of this information is online, it's searchable from a laptop, he continues.

In addition, the portal can bring in other information sources, such as SEC rules and NASD rules, McNally notes. Further, he adds, MFR management can use the portal to share information with the NASD and the SEC on exams they've conducted.

Risk-Based Regulation

Beyond technology to support the examination process, MFR is equipping its examiners - as well as colleagues in enforcement and surveillance - with new tools to slice and dice member firm data. It's all about becoming a smarter regulator - the mandate advocated by Richard Ketchum, the NYSE's first chief regulatory officer who joined the organization in March 2004.

Ketchum is leading the NYSE's watchdog organization toward a risk-based approach to regulation, according to an NYSE spokesman. Rather than wait for the next disaster to happen, NYSE regulators are using the technology tools to become more proactive in identifying risk, he explains.

"Regulators, from the SEC downward - both the NYSE and the NASD - seem to be going to more of a risk-based approach from an auditing and supervisory standpoint," according to Capco's Abramczyk. For example, he notes, both the NYSE and the NASD profile information off Focus reports - financial reports that firms are required to file quarterly and monthly. "It helps the audit if they see areas they want to go after or they see a trend across the firms - it helps establish areas they need to focus on," explains Abramczyk. "They're becoming state of the art," he adds.

For example, last October, NYSE Regulation launched Star Matrix - for Statistical Trend Analysis and Risk Matrix System - a tool that helps analyze data. Accessed from the exchange's intranet, STAR Matrix enables users to perform sophisticated trend analysis at the push of a button and, within seconds, identify potential red flags.

Recognizing that regulatory resources are limited, NYSE officials say the new tools, such as STAR Matrix, will help examiners conduct more-targeted exams. "It's helping them identify risk before going into the field," says NYSE Regulation's Posillico. "Then, through the portal, that data that is analyzed is available to them - they don't have to carry reams of paper."

Since the NYSE regulates the largest, most-complex broker-dealers, MFR also is relying on the tools and the resulting analysis to prioritize which firms, branches and brokers to examine. Of the 5,000 total brokers in the U.S., NYSE Regulation oversees 250 broker-dealers - which account for 90 percent of total customer accounts and 92 percent of customer assets, and operate 19,000 branch offices.

While MFR conducts financial operations (Fin/Op) reviews every year for all 250 firms, in the case of sales practice reviews, the largest firms are examined annually, medium-size firms are examined every other year and small firms are looked at every four years. By mining the data in STAR Matrix, MFR can determine whether there is risk in those firms they monitor less frequently and target those firms with special exams, according to a spokesman for NYSE Regulation.

"In those three off years that we don't go, Fin/Op will conduct their review," explains MFR's Haney. But, on an ongoing basis, MFR will use Star Matrix to find the needle in the haystack, she continues.

One way to conduct trend analysis is to drill into complaint data that results from NYSE Rule 351(d) - the equivalent of NASD Rule 3070 - which requires member firms to file quarterly reports of complaints against brokers. In 2004, there were a total of 11,055 complaints filed against brokers - for problems such as unauthorized trading, misrepresentation and theft; in 2005, there were 5,251 complaints as of late August.

Leveraging STAR Matrix, MFR can identify the firms that had the most complaints and then drill down to the brokers who had the most complaints or rank the branches by percentage of total complaints. If two brokers had a high percentage of the complaints, that would peak the interest of examiners, according to the NYSE's McNally. "Since these two individuals are sharing the same branch, probably you want to pull up the branch profile," he says.

Back to the Future

Next, NYSE Regulation plans to add heat maps to examiners' arsenals to help them visualize geographically where the risk is emerging in products, firms, brokers or branches across regions, counties and states. "It's all going toward trying to understand the risk and act proactively," says MFR's Haney. She notes that the NYSE's 351(d) data comes in quarterly, while amendments come in on an ongoing basis. If the firms are not scheduled for a Sales Practice Review Unit exam for two years, "We're not waiting two years" to review their data, stresses Haney.

While NYSE Regulation contends that it's the only regulatory organization that has state-of-the-art portals, the NASD says it's been supplying its examiners with laptops, scanners and wireless communications for at least three years. "We had rules online for exams for several years," asserts Daniel Sibears, executive vice president of member regulation programs, NASD.

Sibears relates that NASD examiners have been using electronic-based examinations for years, and they have the ability to communicate with each other and interface with the SEC. "I'm not surprised to hear about systems that are evolving that are mirror images," says the NASD executive, who notes that NASD has been open to providing other regulators with guidance and information on how to develop risk-based examinations.

Regardless of which regulator had its systems first, it's clear that both regulators increasingly are mining data to identify risk for the sake of investor protection. Says the NYSE's Haney, "There are all these new ways to slice and dice the data that's going to allow us to do [more]-targeted, focused, smarter, individual-type exams that maybe weren't the norm before."


NYSE Regulation at a Glance

NYSE Regulation is the New York Stock Exchange's independent regulatory division, which plays a role in regulating and monitoring its members, member firms and listed companies. It also enforces compliance with NYSE rules and federal securities laws.

NYSE Regulation Divisions Include:

Member Firm Regulation (MFR), Enforcement, Surveillance, Listed-Company Compliance, as well as Risk/Assessment Unit and Dispute Resolution/Arbitration.

Chief Regulatory Officer: Richard Ketchum

Nearly 700 employees - or 40 percent of the exchange's staff - work for NYSE Regulation.

Member Firm Regulation:

Oversees 250 broker-dealers (member firms), spanning 19,000 branch offices worldwide.

MFR Conducts Three Categories of Examinations:

1. Financial Operations (Fin/Op)

2. Sales Practice Review Unit (SPRU)

3. Member Oversight Unit - floor brokers

MFR Main Office Reviews:

Anti-money laundering, electronic communications (e-mail retention and supervision of e-mail), syndicate and underwriting (compliance with rules associated with new issues and secondary issues), and research reviews.

MFR Branch Office Reviews:

Customer complaints, customer statements suitability of products, and activity in customer accounts. 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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