Thursday, June 16, 2011

Equity Regulatory Alert #2011 - 5
NASDAQ OMX Reminds Members of SEC Rule 15c3-5 Supervision of Market Access

What has been announced?

NASDAQ OMX^® reminds members of The NASDAQ Stock Market^® (NASDAQ^®), NASDAQ OMX BX^SM (BX^SM) and NASDAQ OMX PSX^SM (PSX^SM) that the new market access requirements set forth in SEC Rule 15c3-5 are scheduled to go into effect on July 14, 2011. Rule 15c3-5 prohibits broker-dealers from providing customers with “unfiltered” or “naked” access to an exchange. The rule also requires those who provide access to an exchange put in place risk management controls and supervisory procedures to help prevent erroneous orders, ensure compliance with regulatory requirements and enforce pre-set credit thresholds.

How is market access defined in Rule 15c3-5?

Rule 15c3-5 defines market access as: (i) access to trading in securities on an exchange or alternative trading system as a result of being a member or subscriber of the exchange or alternative trading system; or (ii) access to trading in securities on an alternative trading system provided by a broker-dealer operator of an alternative trading system to a non-broker-dealer.

What controls and procedures must be put in place under Rule 15c3-5?

Financial Risk Management Controls and Supervisory Procedures

The risk management controls and supervisory procedures must be reasonably designed to systematically limit the financial exposure of the broker or dealer that could arise as a result of market access, including being reasonably designed to:

1. Prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds in the aggregate for each customer and the broker or dealer and, where appropriate, more finely-tuned by sector, security, or otherwise by rejecting orders if such orders would exceed the applicable credit or capital thresholds
2. Prevent the entry of erroneous orders, by rejecting orders that exceed appropriate price or size parameters, on an order-by-order basis or over a short period of time, or that indicate duplicative orders

Regulatory Risk Management Controls and Supervisory Procedures

The risk management controls and supervisory procedures must be reasonably designed to ensure compliance with all regulatory requirements, including being reasonably designed to:

1. Prevent the entry of orders unless there has been compliance with all regulatory requirements that must be satisfied on a pre-order entry basis
2. Prevent the entry of orders for securities for a broker or dealer, customer, or other person if such person is restricted from trading those securities
3. Restrict access to trading systems and technology that provide market access to persons and accounts pre-approved and authorized by the broker or dealer
4. Assure that appropriate surveillance personnel receive immediate post-trade execution reports that result from market access

Allocation of Risk Management Controls and Supervisory Procedures

The financial and regulatory risk management controls and supervisory procedures shall be under the direct and exclusive control of the broker or dealer. A broker or dealer may reasonably allocate, by written contract, after a thorough due diligence review, control over specific regulatory risk management controls and supervisory procedures to a customer that is a registered broker or dealer, provided that such broker or dealer has a reasonable basis for determining that such customer has better access than the broker or dealer to that ultimate customer and its trading information such that it can more effectively implement the specified controls or procedures. Any allocation of control shall not relieve a broker or dealer from any obligation including the overall responsibility to establish, document, and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory and other risks of market access.

Review of Controls and Supervisory Procedures

A broker or dealer must establish, document and maintain a system for regularly reviewing the effectiveness of the risk management controls and supervisory procedures.

1. Among other things, the broker or dealer shall review, no less frequently than annually, the business activity of the broker or dealer in connection with market access to assure the overall effectiveness of such risk management controls and supervisory procedures. Such review shall be conducted in accordance with written procedures and shall be documented. The broker or dealer shall preserve a copy of such written procedures, and documentation of each such review, as part of its books and records in a manner consistent with §240.17a-4(e)(7) and §240.17a- 4(b), respectively.
2. The Chief Executive Officer (or equivalent officer) of the broker or dealer shall, on an annual basis, certify that such risk management controls and supervisory procedures comply with paragraphs (b) and (c) of this section, and that the broker or dealer conducted such review, and such certifications shall be preserved by the broker or dealer as part of its books and records in a manner consistent with §240.17a-4(b).

Do I need to do anything differently?

All members with market access should ensure that they establish, document and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory and other risks, including access on behalf of sponsored customers.

Where can I find additional information?

• Refer to SEC Release 2010-210.
• Contact Transaction Services U.S. Market Sales at +1 800 846 0477.