The Securities and Exchange Commission is warning brokerages to make sure their compliance departments are involved when building new trading systems.
Speaking at the TradeTech USA conference in New York last week, Duer Meehan, associate director of the Office of Market Oversight in the SEC’s Office of Compliance Inspections and Examinations, told attendees “there has been an increase in compliance issues that arise when entities fail to involve compliance in the development process.”
The official, who is a former trader and also designed trading systems at Bloomberg, also warned the crowd to involve compliance during the testing phase of any new system, “to ensure that compliance failures are not the result of a lack of inadequate and thorough testing.”
When confronted with “compliance failures” by the SEC, Meehan said, firms will often admit to not involving their compliance departments in the development of their systems. They also tell the SEC they did not do too much testing before launching the system. “From a regulatory standpoint,” Meehan said, “that raises red flags about a firm’s compliance culture.”
Meehan would not cite specific examples, but told Traders Magazine: “People roll out a new system. Something goes wrong. And then you find out the regulatory people were not involved. I understand there is pressure on firms to compete, to get things out fast, but they need to slow down.”
Industry executives say compliance usually is brought into the development process, but problems can still arise. The reasons given vary.
High turnover among trading and compliance staff is one factor, sources say. New compliance officials join a project midstream and consequently aren’t as familiar with the project as they could be.
At the larger firms, others say, there can be an attitude of not caring about compliance. Large firms are less concerned about regulatory fines in the thousands of dollars.
Others offer a different perspective. Jess Haberman, chief compliance officer at Fidessa, a trading systems developer, notes there is “variability in the involvement that compliance officers at broker-dealers take in the design and monitoring of automated systems.” But, “the bigger broker-dealers, probably because they have a larger staff, can devote more time to having people specifically tasked with ensuring that the systems they use conform to their requirements.”
Smaller broker-dealers rely more on Fidessa for expertise, Haberman says, although “even for very large firms with strong internal compliance and technology groups, it can be tough to maintain their programs. There is an advantage to using a vendor like Fidessa.”
Others note that errors creep into the development process despite the best intentions and efforts of those involved. The degree to which compliance bugs invade a system can depend on whether the system was developed in-house or externally by a vendor.
In the case of an outside vendor, sometimes there is no compliance official on staff. “The problem then becomes: How do you test these things out for compliance?” Michael “Mickey” Rosen, senior vice president, product management, at agency brokerage UNX. “They don’t have the code. They are not looking at the actual code. They are just looking at the output. So if something happens, they don’t know why it is happening.”
The problem is less severe when the development is done in-house, as compliance is brought in at the start of a project. Errors creep into the process because there are nuances in development that elude the compliance official who is not trained in software coding. “Even if you have a really closed loop, you are not going to eradicate all the problems because of the nature of systems development,” Rosen says.
Rosen explains there is no typical flaw, but an example might be the proper marking of trades. “The programmers are working with the traders and the product people, who are looking to make the systems as seamless and efficient as possible,” he notes. “The compliance officials are worrying about the one-in-a-million outliers that shouldn’t break the law. It’s hard to make everybody happy, and at the same, time eradicate all the bugs; making sure there are no violations and have a system work properly.”
The problem is not a new one, sources say, but has grown as the industry has become more systems-focused. What is new is the degree to which the SEC is scrutinizing industry practices. The regulator is taking heat for the collapse of several banks, so its posture under incoming chairwoman Mary Schapiro has become more aggressive, sources say.
