SEC Settles Charges Against Broker-Dealer Personnel For Violating Market Structure Rules

The CEO of a Utah-based broker-dealer and two associated registered persons settled charges with the SEC for (i) relying improperly on a bona fide market-making exception to the “locate” requirement for short sales in Regulation SHO Rule 203(b), and (ii) violating Section 15(c)(3) of the Exchange Act and Rule 15c3-5 (the “Market Access Rule”) by failing to implement reasonably designed controls and supervisory procedures for managing the risks of market access.

According to the SEC, the firm’s CEO violated the certification requirement of the Market Access Rule by signing the certification “without being familiar with the rule, not knowing who at the firm was responsible for compliance with [the rule], nor making reasonable inquiries about the firm’s annual review and the results of any such review.”

“This is the first time that the SEC has charged the CEO of a broker-dealer with violating the CEO certification requirement of the Market Access Rule,” the SEC stated.

The settlement Order requires individual respondents to cease and desist from broker-dealers for violations of the Reg. SHO and other Exchange Act requirements and to pay disgorgement, pre-judgment interest and civil penalties. Additionally, the SEC announced an administrative cease-and-desist proceeding against the broker-dealer firm for violations of the Reg. SHO, Section 15(c)(3), and Rule 15c3-5(b), (c) and (e). This proceeding has yet to be settled.

The SEC settlement Order against the individual respondents contains a fair amount of discussion about the bona fide market-making exception in Reg. SHO and why the broker-dealer’s activity did not satisfy it. The SEC noted that the firm’s policies and procedures required its proprietary traders to make two-way markets in the securities in which they were registered as market-makers. In this case, neither the firm nor the traders took steps to ensure that the actual trading satisfied the market-making exception. The SEC asserted that either the broker-dealer or the trader could have reviewed the trader’s quotations (e.g., to see if they were continuous or near the best bid/offer) and any short sales executed away from posted quotes in order to determine whether the trading qualified as market-making.

The policies behind the adoption of Rule 15c3-5 might be debatable, but in this instance (as in that of another recent enforcement action under the rule), the case (at least against the personnel in the settled proceedings) seems straightforward. The SEC noted that the firm had no controls to prevent orders over pre-set capital thresholds (though the head trader monitored trading as it occurred) or particular price or size parameters. Further, the SEC found that the CEO “did not know who at the firm was responsible for compliance with [Rule 15c3-5]” and made no inquiries into the review process while making his certification.

Despite the fact that these violations should have been clear enough to avoid, firms should continue to review their compliance checks and exception reports as SEC enforcement actions under to Rule 15c3-5 continue to mount.

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