Rule 15c3-5 — Risk Management Controls for Brokers or Dealers with Market Access

A Small Entity Compliance Guide¹

Overview

On November 3, 2010, the Commission adopted a new rule to require brokers and dealers to have risk controls in connection with their market access. Rule 15c3-5 is intended to address the risks that can arise as a result of the automated, rapid electronic trading strategies that exist today, and bolster the confidence of investors in the integrity of our markets. Rule 15c3-5 would effectively eliminate the practice known as "unfiltered" or "naked" access to an exchange or an ATS.

Requirement to Maintain Risk Management Controls and Supervisory Procedures

Rule 15c3-5 is applicable to broker-dealers with access to trading securities, by virtue of being an exchange member, an ATS subscriber, or an ATS operator with non-broker-dealer subscribers. Such broker-dealers with market access would be required to establish, document, and maintain a system of risk management controls and supervisory procedures that, among other things, are reasonably designed to: (1) systematically limit the financial exposure of the broker or dealer that could arise as a result of market access, and (2) ensure compliance with all regulatory requirements that are applicable in connection with market access. Specifically, the risk management controls and supervisory procedures would be required to be reasonably designed to:

• prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous;

• prevent the entry of orders unless there has been compliance with all regulatory requirements that must be satisfied on a pre-order entry basis; and

• prevent the entry of orders that the broker-dealer or customer is restricted from trading, restrict market access technology and systems to authorized persons, and assure appropriate surveillance personnel receive immediate post-trade execution reports.

Direct and Exclusive Broker-Dealer Control Over Financial and Regulatory Risk Management Controls and Supervisory Procedures

The broker-dealer with market access would also be required to have direct and exclusive control of its financial and regulatory risk management controls and supervisory procedures, with a limited exception that would permit the reasonable allocation of certain regulatory controls and procedures to a customer that is a registered broker-dealer.

Limited Exception for Routing Broker-Dealers

There is a limited exception from the provisions of the Rule for broker-dealers that provide outbound routing services to an exchange or ATS for the sole purpose of accessing other trading centers with protected quotations on behalf of the exchange or ATS in order to comply with Rule 611 of Regulation NMS, or the Options Linkage Plan for listed. These routing brokers would be required to comply with the provisions of Rule 15c3-5 designed to prevent the entry of erroneous orders to help ensure that order handling by an exchange or ATS router would not increase risk to the market.

Regular Review of Risk Management Controls and Supervisory Procedures

Rule 15c3-5 requires broker-dealers with market access to establish, document, and maintain a system for regularly reviewing the effectiveness of the risk management controls and supervisory procedures and for promptly addressing any issues; and no less frequently than annually, conduct a review of its business activity in connection with market access to assure the overall effectiveness of such risk management controls and supervisory procedures and document that review.

The Rule would also require the Chief Executive Officer of the broker or dealer to annually certify that the risk management controls and supervisory procedures comply with Rule 15c3-5, and that such regular review has been conducted. The Rule 15c3-5 CEO certification requirement is a separate and distinct certification from the FINRA Rule 3130 certification requirement; however a FINRA member firm could leverage its current process for compliance with FINRA Rule 3130 to perform the required certification under the Rule. For instance, a FINRA member could combine in the same document the CEO certification required by the Rule with the FINRA 3130 or other required certifications, if the substance of each of the required certifications is contained in that document.

Other Resources

The final adopting release for Rule 15c3-5 can be found on the SEC's website at http://www.sec.gov/rules/final/2010/34-63241.pdf. The proposing release can be found on the SEC's website at http://www.sec.gov/rules/proposed/2010/34-61379.pdf.

Contacting the SEC

The SEC's Division of Trading and Markets is happy to assist small entities with questions regarding Rule 15c3-5. The Division's Office of Interpretation and Guidance answers questions submitted by email and telephone. You can submit a question by email to tradingandmarkets@sec.gov or you can contact the Office of Interpretation and Guidance at (202) 551-5777.

Implementation

Rule 15c3-5 will be effective 60 days from the date of publication in the Federal Register. Once effective broker-dealers subject to the rule will have six months to comply with the requirements of Rule 15c3-5.

Endnotes

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¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a "small entity compliance guide" under section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements

http://www.sec.gov/rules/final/2010/34-63241-secg.htm