Guidelines for Supervision
Guidelines for Supervision of Proprietary Trades
By: Lisa Sussman
FINRA has released guidelines (see Regulatory Notice 08-18) with respect to preventing and detecting unauthorized trading in proprietary accounts in the wake of several recent cases involving this practice. While risk management recommendations and suggested practices have been identified for a number of years, FINRA believes that firms must reassess their practices based on marketplace changes, the pervasiveness of electronic trading and the complexity and speed with which transactions occur.
Some proprietary trading accounts are profit-generators for firms and unauthorized trading may sometimes be “overlooked” if the account is generating revenue. However regulatory risks must be kept in check with tight internal controls. FINRA has identified six sound practices for preventing and detecting unauthorized trading:
1. Mandatory Vacation Policies – Instituting a mandatory policy where traders must be off the desk for ten consecutive trading days. This should help expose any unauthorized activity. This may be a mandatory vacation or a reassignment of duties; as long as the employee has no physical or electronic access to the firm’s trading systems.
2. Heightened Scrutiny of Red Flags – Reviewing trade data for red flags such as:
- Trading limit breaches;
- Unrealized P&L on unsettled transactions;
- Unusual patterns of cancellations and corrections;
- Transactions where confirmation and settlement are not timely;
- Reports of ages unresolved reconciling items and aged outstanding confirmations;
- Reports of P&L that exceed certain de minimus amount by traders who are supposed to be flat, or unusually large one-day P&L reports;
- Risks associated with traders positions such as Value at Risk, liquidity risk, and hedging risks;
- Repeated or unusual requests by a trader to relax existing controls;
- Trading in products outside a traders expertise;
- Differences between a trader’s account positions and the account activity; or
- Patters of aged fails to deliver for long or short sales.
3. Protection of Systems and Risk Management Information – limit employee access to trading systems, passwords, knowledge of trading surveillance to what is appropriate for their job function.
4. Supervision and Accountability – Managers, with employees reporting to multiple supervisors, must have clear lines of reporting and responsibility for each so they may be held accountable for their day-to-day job responsibilities
5. Intercompany transactions – Often, firms conducting transactions with affiliated companies may relax controls. FINRA suggests that firms re-evaluate this practice and put into place controls that limit exposure; including reconciliations of intercompany transactions and balance on a regular basis.
6. Compliance Culture – FINRA reminds firms that effective compliance starts with the “tone at the top.” Fostering an environment where employees and supervisory personnel are encouraged to ask questions, raise issues about suspicious activity, give incentives to traders who disclose losses promptly and adequately compensate and fund internal control functions is considered a best practice.
Regulatory Compliance strongly encourages each firm to review their policies and procedures to ensure that they are adequate to protect the assets of both your customers and the firm. For more information on FINRA’s guidance or assistance in amending procedures to address proprietary accounts, please call your Compliance Partners Account Manager at 603-434-3594 ext. 124 for Beverly or ext. 122 for Jane.