The Securities and Exchange Commission today issued a staff report intended to help broker-dealers safeguard confidential information from misuse, such as insider trading. The report by the Office of Compliance Inspections and Examinations (OCIE) describes strengths and weaknesses identified in examinations into how broker-dealers keep material nonpublic information from being misused.
This report should help broker-dealers assess the effectiveness of their controls over sensitive information,” said OCIE Director Carlo di Florio. “The report illustrates the types of conflicts of interest that may arise between a broker-dealer’s obligations to clients that provide confidential information for business purposes and the potential misuse of such information for insider trading or other improper ends. It also describes various methods that broker-dealers use to identify and effectively manage such conflicts, including information barriers that limit the flow of sensitive information.”
Conflicts of interest and other issues of concern raised by the report include:
- A significant amount of informal, undocumented interaction occurred between groups that have material nonpublic information and internal and external groups with sales and trading responsibilities that might profit from the misuse of such material nonpublic information
- At some broker-dealers, a senior executive might have access to material nonpublic information from one business unit while overseeing a different unit that could potentially profit from misuse of that information, with few if any restrictions or monitoring to prevent such misuse
- Some broker-dealers did not have risk controls to address certain business units that possess material nonpublic information such as sales, trading or research personnel who receive confidential information for business purposes; institutional and retail customers or asset management affiliates with access to material nonpublic information, or firm personnel who receive information through business activities outside of investment banking, such as participation in bankruptcy committees or through employees serving on the boards of directors of public companies.
The report also highlights effective practices that examiners observed at some broker-dealers, such as:
- Broker-dealers sometimes adopted processes that differentiate between types of material nonpublic information based on the nature of the information or where it originated. In some cases, broker-dealers create tailored “exception” reports that take into account the different characteristics of the information
- Some broker-dealers expanded reviews for potential misuse of confidential information to include trading in credit default swaps, equity or total return swaps, loans, components of pooled securities such as unit investment trusts and exchange traded funds, warrants, and bond options
- Broker-dealers often considered electronic sources of confidential information and instituted monitoring to identify which employees had accessed the information
- Broker-dealers often monitored access rights for key cards and computer networks to confirm that only authorized personnel had access to sensitive areas.
The types of issues identified in this report may be helpful to firms as they review their conflict of interest risk management programs. In particular, in any review of information barriers control programs, broker-dealers should be alert to changes in business practices and available compliance tools.
Christine Sibille of OCIE’s Washington D.C. office played a key role in producing the report. In addition to Ms. Sibille, the following OCIE staff worked on the examinations underlying the report: Roberta Boyd, Jane Cash, Michelle B. Davis, Everardo DeArmas, Juanita Hamlett, Wanda Hunter, Judy Lee, Danielle Perfetuo, and Lisa Wardlaw in the Washington, D.C. office, and Claudia Arroyo, Theresa D. Gleason, Stephanie Morena, John M. Nee, and Hermann Vargas in the New York Regional Office.