Developing a Robust Compliance Program for Broker-Dealers

Given the significant sums of money involved and the various financial instruments they deal with, broker-dealers are subjected to stringent regulatory scrutiny including the Anti-Money Laundering and Counter Financing of Terrorism (AML/CFT) areas. In the United States, these regulations primarily derive from the Bank Secrecy Act (BSA) and the USA Patriot Act. Under these regulations, broker-dealers are required to maintain comprehensive records of financial transactions and report suspicious activities to the Financial Crimes Enforcement Network (FinCEN) when potential money laundering is detected. Recently, broker-dealer firms were a key focus of the SEC’s AML efforts, representing a substantial portion of enforcement actions.

Broker-dealers play a pivotal role in the operation of financial markets by offering liquidity, transparency, and effective execution of securities transactions. Undoubtedly, their significance in the financial industry is paramount, as they facilitate investor access to a wide range of financial instruments, risk management, and the orderly operation of markets. Likewise, the adherence of broker-dealers to compliance standards is equally crucial to maintaining the integrity and trustworthiness of these markets.

Compliance Regulations that Impact Broker-Dealers

Some of the major compliance regulations that impact broker-dealers in the U.S. include:

Securities Exchange Act of 1934

This foundational legislation governs the trading and registration of securities and establishes requirements for market participants, including broker-dealers. It also created the U.S. Securities and Exchange Commission (SEC), which plays a central role in regulating broker-dealers.

Anti-Money Laundering (AML) Regulations

Broker-dealers are obligated to comply with AML regulations to prevent and report suspicious transactions and money laundering activities. These regulations include the Bank Secrecy Act (BSA) and the USA Patriot Act, which require the maintenance of customer identification and transaction monitoring procedures. The Bank Secrecy Act, enacted in 1979, establishes the foundational AML compliance framework for all financial institutions, including banks and broker-dealers. Under the BSA, broker-dealers are subject to regulatory oversight by the U.S. Treasury. They are mandated to maintain records of financial transactions and, when detecting suspicious activity suggestive of money laundering, report such instances to the Financial Crimes Enforcement Network (FinCEN). Specific provisions regarding broker-dealers can be found in Part 1023 of the BSA (31 C.F.R. §§ 1023.100 et seq.).

The USA Patriot Act, introduced in 2001 following the September 11 terrorist attacks, serves as a legislative enhancement to the BSA. Its primary purpose is to fortify AML efforts by focusing on improving customer due diligence and monitoring measures. The Patriot Act necessitates that broker-dealers establish and execute a written, risk-based AML program. This program should encompass policies, procedures, and controls that are reasonably expected to ensure compliance with the BSA. Furthermore, the AML requirements outlined in the Patriot Act should support:

• Know Your Customer (KYC) and Customer Due Diligence (CDD) Requirements: Broker-dealers are required to have robust KYC and CDD procedures in place to verify the identity of their customers and assess the potential risks associated with their transactions.
• Securities Investor Protection Act (SIPA): This regulation established the Securities Investor Protection Corporation (SIPC) to protect customers of insolvent broker-dealers by providing insurance coverage for their assets held by the broker-dealer.
• Regulation Best Interest (Reg BI): Introduced by the SEC, Reg BI enhances the standard of conduct for broker-dealers when making investment recommendations to retail customers. It obliges broker-dealers to prioritize their customers’ best interests.
• Financial Industry Regulatory Authority (FINRA) Rules: FINRA, a self-regulatory organization, establishes rules that broker-dealers must follow. These rules cover areas such as trading practices, communications with the public, and dispute resolution.
• Order Handling Rules: These regulations stipulate how broker-dealers handle customer orders and ensure they seek to achieve the best execution for their customers.
• Market Access Rule: Broker-dealers are subject to rules related to providing access to securities exchanges. This regulation is designed to prevent disruptions and maintain market integrity.
• Securities Act of 1933: This law governs the registration of securities and their initial sale, impacting broker-dealers involved in underwriting or distribution of securities.
• Compliance with Anti-Fraud Regulations: Broker-dealers are required to adhere to a variety of anti-fraud regulations, such as Rule 10b-5 under the Securities Exchange Act, which prohibits fraudulent practices in connection with securities transactions.

These are just a few of the major compliance regulations that broker-dealers in the United States must navigate. Compliance is essential to maintain market integrity, protect investors, and ensure the smooth functioning of the financial system. The regulatory landscape may evolve, so broker-dealers must stay updated on changes and adapt their compliance programs accordingly.

Building an Effective Broker Dealer Compliance Program

In this section, we will walk you through the process of building a broker-dealer compliance program that not only keeps your business on the right side of the law but also fosters trust and confidence with clients and regulators.

1. Understanding the Regulatory Landscape

The first step in building a compliance program is understanding the regulatory landscape. Broker-dealers are subject to various rules and regulations, including those imposed by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and state securities regulators. It’s crucial to have a clear grasp of the rules that apply to your specific business model and the jurisdictions in which you operate.

2. Creating a Top Notch Compliance Team

The next vital component is assembling a dedicated compliance team. Your team should be composed of professionals with in-depth knowledge of securities regulations, and they should be responsible for ensuring that your firm operates in compliance with all relevant laws. Training and ongoing education are essential to keep your team up to date with changing regulations.

3. Empower Your Chief Compliance Officer

In light of FINRA’s focus on firm culture during examinations, it is crucial for brokerages to bestow CCOs with increased decision-making authority. CCOs should function as the center of the firm’s culture, steering and molding the organization’s ethical character while upholding compliance with regulatory requirements. To cultivate the desired culture, it’s imperative to establish open lines of communication between CCOs and C-Suite leadership and equip them with cutting-edge regtech tools to enhance the monitoring of Suspicious Activity Reports (SARs) and employee surveillance.

4. Developing Compliance Policies and Procedures

With your team in place, the next step is to develop comprehensive compliance policies and procedures. These documents serve as the foundation of your program, outlining how your firm will meet its regulatory obligations. Key components to consider include:

• Know Your Customer (KYC) procedures
• Anti-Money Laundering (AML) policies
• Supervision and surveillance protocols
• Trade reporting and record-keeping procedures
• Conflict of interest policies
• Cybersecurity measures
• Business continuity and disaster recovery plans

5. Risk Assessment

Conduct a thorough risk assessment to identify areas where your firm might be vulnerable to compliance issues. This assessment should consider the nature of your business, the types of securities you deal with, and the specific risks associated with your operations. Based on the findings, prioritize your compliance efforts to address high-risk areas first.

6. Devise a Strategy Based on Risk

Although the SEC presently permits brokerages to depend on their registered investment adviser (RIA) counterparts for Anti-Money Laundering (AML) protection, recent actions taken by FINRA present a different perspective. FINRA’s enforcement efforts target brokerages engaged in high-volume transactions of microcap or penny stock securities, deeming them “high-risk business models.” Consequently, risk assessments must be tailored to the size, scale, and extent of a brokerage’s operations, demanding a comprehensive evaluation of trading technology, personnel, business partners, and transaction-monitoring systems. Relying solely on AML controls within the RIA sector is not a sufficient approach for broker-dealers.

7. Implementing Compliance Training

Once your policies and procedures are in place, it’s crucial to provide training to all employees. Ensure that everyone in your organization understands the importance of compliance and is aware of the specific requirements they need to follow in their roles. This training should be ongoing, with regular updates and refresher courses.

8. Monitoring and Testing

Compliance is not a one-time effort; it requires ongoing monitoring and testing. Implement systems and controls that allow you to track and verify compliance with your policies and procedures. Regularly review your operations, conduct compliance audits, and address any identified issues promptly.

9. Reporting and Record-Keeping

Accurate and thorough record-keeping is a cornerstone of any compliance program. Ensure that all required records are maintained, and establish a robust reporting system to promptly notify regulators of any significant compliance breaches.

10. Addressing Regulatory Changes

Securities regulations are not static; they change over time. Stay informed about regulatory updates and be prepared to adjust your compliance program accordingly. This includes making necessary updates to policies, procedures, and employee training.

11. Cultivating a Culture of Compliance

In addition to the technical aspects of compliance, it’s crucial to foster a culture of compliance within your organization. Employees should understand the importance of adhering to the rules and regulations, not just as a legal requirement but as a commitment to ethical business practices.

12. Engaging with Regulators

Maintain open and transparent communication with regulators. Respond to inquiries promptly and cooperate with examinations or investigations as required. A positive relationship with regulators can be beneficial in case of any compliance issues.

13. Safeguard Whistleblowers

The SEC is actively addressing BD-employee confidentiality agreements that contravene Section 21F-17 of the Securities Exchange Act of 1934, designed to shield whistleblowers. It is imperative that broker-dealers guarantee that their compliance manuals, codes of ethics, employment agreements, and severance agreements overtly provide protection for employees who report misconduct. This emphasis on protecting whistleblowers aligns with regulators’ increased focus on organizational culture during examinations in the brokerage industry.

14. Leverage Regtech

Regtech solutions empower broker-dealers to efficiently manage large volumes of data, monitor transactions, conduct risk assessments, and ensure adherence to stringent regulatory requirements. By automating routine tasks, regtech frees up compliance professionals to focus on more strategic and complex issues, ultimately improving the overall effectiveness and accuracy of compliance efforts. In an ever-evolving regulatory landscape, regtech has emerged as a crucial asset for broker-dealers, enabling them to stay ahead of compliance challenges and minimize the risk of penalties and reputational damage.

The Role of VComply in Ensuring Broker Dealer Compliance

VComply automates and streamlines the complex compliance and reporting obligations of broker-dealers providing a comprehensive solution that addresses the unique challenges within the financial services sector and enhances operational efficiency.

VComply helps you manage your intricate regulatory landscape, including the Securities Exchange Act of 1934, Investment Advisers Act of 1940, SEC rules and regulations, data protection standards such as GDPR and CCPA, as well as AML and KYC compliance requirements, along with the mandates of regulatory bodies like SEC, FINRA, and state securities authorities.

Conclusion

Building a broker-dealer compliance program is a complex but vital task for any firm operating in the securities industry. By understanding the regulatory landscape, creating a compliance team, developing policies and procedures, conducting risk assessments, and prioritizing training and monitoring, you can establish a program that not only keeps your business in compliance but also instills confidence in clients and regulators. Compliance is not a one-time effort; it’s an ongoing commitment to ethical and legal business practices.