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January 7, 2008

Passing the Buck: Regulators Say All Introducing Broker-Dealers Must Ensure Reg NMS Compliance

Clearing Quarterly & Directory

By John Hintze

Also in this article

Assume nothing.

That’s the approach that clearers and their clients should take as Regulation National Market System rules are in force, according to clearing consultants and regulators.  They warn that Reg NMS ignorance will be no defense when Securities and Exchange Commission examiners start looking at the clearers’ books.


Reg NMS, a controversial rule passed by the SEC on a 3-2 vote, stipulates a set of trade-through policies and procedures. The rule is designed to ensure that the investor receives the best price.


And in this new Reg NMS world, those relying on their clearers or other parties to execute their trades are cautioned that they also have significant compliance responsibilities.  And these responsibilities are still trickling down, even as the next round of regulatory examinations approaches.  The largest Wall Street firms, with their legions of compliance officers and attorneys—who in many cases played a role in developing the new rules—should have no problems. But smaller broker-dealers can’t just palm off Reg NMS responsibility to their clearers, cautions one regulator.


Broker-dealers can’t push compliance off on the executing broker, says Lori Richards, director in the SEC’s Office of Compliance Inspections and Examinations, since traditionally each broker-dealer is ultimately responsible for its own regulatory compliance. She says the rule requires trading centers, including exchanges, ECNs and market makers, to conduct regular surveillance to ascertain the effectiveness of the trade-through rule. For the rest of the brokerage industry, she adds, they should have records to demonstrate they also comply.


Here Come the Examiners


“Examiners will review the firm’s records of its surveillance reviews and the firm’s procedures governing its surveillance reviews,” Richards says. “Examiners will also check to see if the firm took prompt action to remedy any deficiencies uncovered by its surveillance reviews.” Still, if Carolyn May’s experience as a consultant on compliance issues indicates the preparedness of the broker-dealer community, the SEC is likely to find plenty of Reg NMS problems.


May is a director and compliance officer at Simmons First Investment Group, a bank-affiliated broker-dealer. She is also a compliance consultant for 25 other broker-dealers and registered investment advisory firms. Her brokerage customers are all introducing firms. Many rely on their correspondent clearers to execute trades.   


She says broker-dealers that hand over control of order executions to third-party broker-dealers such as clearers are still responsible for ensuring that those parties are complying with Reg NMS—although many of her customers have yet to focus on that responsibility or are uncertain about what it involves. In fact, she says, even actively trading customers that have the trading platforms to access market centers directly to execute trades—those Reg NMS affects most directly—could have some problems.


 “I have a couple of firms that do have those resources, and quite frankly, they’re not familiar with Reg NMS. This is one of those rules that people are just not understanding,” May says. That’s problematic at this late stage, because