Federal Register, Volume 75, Number 219, November 15, 2010, Pages 69571-69850 Page: 69,802
viii, 69849, iii p. ; 28 cm.View a full description of this periodical.
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69802 Federal Register/Vol. 75, No. 219/Monday, November 15, 2010/Rules and Regulations
the nature of the business and customer
base, so long as they are reasonably
designed to achieve the goals articulated
in the Rule. In many cases, particularly
with respect to proprietary trading and
more traditional agency brokerage
activities, the Rule may be substantially
satisfied by existing financial risk
management controls and supervisory
procedures already implemented by
broker-dealers. However, the
Commission believes that the Rule
should help to assure that a consistent
standard applies to all broker-dealers
providing any type of market access
and, importantly, will address the
serious gap that exists with those
broker-dealers that today offer
"unfiltered" sponsored access.
Under Rule 15c3-5(c)(1)(i), the
broker-dealer's controls and procedures
must be reasonably designed to prevent
the entry of orders that exceed
appropriate pre-set credit or capital
thresholds in the aggregate for each
customer and the broker-dealer, and
where appropriate more finely-tuned by
sector, security, or otherwise, by
rejecting orders if such orders exceed
the applicable credit or capital
thresholds. Under this provision, a
broker-dealer will be required to set
appropriate credit thresholds for each
customer for which it provides market
access, including broker-dealer
customers,88 and appropriate capital
thresholds for proprietary trading by the
broker-dealer itself. The Commission
expects broker-dealers will make such
determinations based on appropriate
due diligence as to the customer's
business, financial condition, trading
patterns, and other matters, and
document that decision. In addition, the
Commission expects the broker-dealer
will monitor on an ongoing basis
whether the credit thresholds remain
appropriate, and promptly make
adjustments to them, and its controls
and procedures, as warranted.
In addition, because the controls and
procedures must be reasonably designed
to prevent the entry of orders that
exceed the applicable credit or capital
thresholds by rejecting them, the broker-
dealer's controls must be applied on an
automated, pre-trade basis, before orders
are routed to the exchange or ATS.
Furthermore, because the risis
management controls and supervisory
procedures should be designed such
88Th broker-dealer providing market access may
also wish to supplement the overall credit limit it
places on the activity of its broker-dealer customers
with assurances from those broker-dealer customers
that they have implemented controls reasonably
designed to assure that trading by their individualcustomers remains within appropriate pre-set credit
thresholds.that rejection must occur if such orders
would exceed the applicable credit or
capital thresholds, the broker-dealer
must assess compliance with the
applicable threshold on the basis of
exposure from orders entered on an
exchange or ATS, rather than relying on
a post-execution, after-the-fact
determination. Because financial
exposure through rapid order entry can
be incurred very quickly in today's fast
electronic markets, controls should
measure compliance with appropriate
credit or capital thresholds on the basis
of orders entered rather than executions
obtained. As noted above, however, in
appropriate cases reasonable risk
management models may be used to
discount the credit or capital exposure
generated by outstanding but
unexecuted orders.
Under Rule 15c3-5(c)(1)(ii), the
broker-dealer's controls and procedures
must be reasonably designed to 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.
Given the prevalence today of high-
speed automated trading algorithms and
other technology, and the fact that
malfunctions periodically occur with
those systems, the Commission believes
that broker-dealer risk management
controls should be reasonably designed
to detect malfunctions and prevent
orders from erroneously being entered
as a result, and that identifying and
blocking erroneously entered orders on
an order-by-order basis or over a short
period of time would accomplish this.
These controls also should be
reasonably designed to prevent orders
from being entered erroneously as a
result of manual errors (e.g., erroneously
entering a buy order of 2,000 shares at
$2.00 as a buy order of 2 shares at
$2,000.00). For example, a systematic,
pre-trade control reasonably designed to
reject orders that are not reasonably
related to the quoted price of the
security would help prevent
erroneously-entered orders from
reaching the market.89 As with the
financial risk management controls and
supervisory procedures relating to credit
or capital thresholds, the broker-dealer
also would be required to monitor on a
regular basis whether its controls and
procedures are effective in preventing
the entry of erroneous orders, and
89In this regard, the Commission notes that some
markets provide price collars for market orders to
help ensure that executions are reasonably relatedto the quoted price. See e.g. NYSE Arca Rule 7.31(a)
and Nasdaq Rule 4751.promptly make adjustments to them as
warranted.
The Commission emphasizes that the
financial risk management controls and
supervisory procedures described in
Rule 15c3-5(c) should not be viewed as
a comprehensive list of those that
should be utilized by broker-dealers.
Instead, the Rule simply sets a uniform
baseline standard for the types of
financial risk management controls and
supervisory procedures that a broker-
dealer with market access should
implement. A broker-dealer may, for a
variety of reasons, implement financial
risk management controls and
supervisory procedures above and
beyond those specifically described in
the Rule, depending on the nature of its
business, customer base, and other
specific circumstances.
E. Regulatory Risk Management
Controls and Supervisory Procedures
As noted above, Proposed Rule 15c3-
5(c) requires a broker-dealer's risk
management controls and supervisory
procedures to include certain elements.
Proposed Rule 15c3-5(c)(2) deals with
regulatory compliance risk, and requires
that the risk management controls and
supervisory procedures be reasonably
designed to ensure compliance with all
regulatory requirements that are
applicable in connection with market
access, 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 that the broker-dealer,
customer, or other person, as applicable,
is restricted from trading; (3) restrict
access to trading systems and
technology that provide market access
to persons and accounts pre-approved
and authorized by the broker-dealer;
(4) assure that appropriate surveillance
personnel receive immediate post-trade
execution reports that result from
market access.
Several commenters were concerned
with the scope of the Rule, particularly
to the extent it requires controls and
procedures reasonably designed to
ensure compliance with all regulatory
requirements applicable in connection
with market access.90 These
commenters requested that the
Commission clarify that the proposed
rule would not impose new regulatory
obligations on broker-dealers that
provide access to trading on an90 ConvergEx Letter at 6; SIFMA Letter at 6; ITG
Letter at 4.
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United States. Office of the Federal Register. Federal Register, Volume 75, Number 219, November 15, 2010, Pages 69571-69850, periodical, November 15, 2010; Washington D.C.. (https://digital.library.unt.edu/ark:/67531/metadc52800/m1/238/: accessed April 26, 2024), University of North Texas Libraries, UNT Digital Library, https://digital.library.unt.edu; crediting UNT Libraries Government Documents Department.