Bridging the Week by Gary DeWaal: January 4 – 8 and 11, 2016 (Spoofing; Sentinel Management; Steven A. Cohen; AML; Block Trades)

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Published Date: January 10, 2016

Last week, the Financial Industry Regulatory Authority announced its regulation and examination priorities for 2016. The big surprise was that FINRA will soon be issuing to member firms monthly report cards showing possible layering or spoofing activities. In addition, a federal appeals court held that the bank funding a loan to a now defunct investment management firm just prior to its filing for bankruptcy in 2007 was on inquiry notice that something was wrong with the collateral it received to support the loan—that it included customer collateral, not just house collateral. Also, Steven A. Cohen settled failure to supervise charges by the Securities and Exchange Commission with payment of no fine. In addition, I include a special stand-alone Compliance Weeds dealing with block trades. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Note: In respect of the Martin Luther King holiday in the United States on January 18, the next edition of Bridging the Week will be on January 19, 2016.

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FINRA Will Grade Members on Culture, Supervision and Liquidity Management; BDs Not Managing Spoofing Likely to Get Bad Scores:

The Financial Industry Regulatory Authority kicked off the new year by issuing its annual Regulatory and Examination Priorities Letter. This year, FINRA indicated that its emphasis will be on three areas: (1) culture, conflicts of interest and ethics; (2) supervision, risk management and controls; and (3) liquidity.

To evaluate a firm’s culture, FINRA indicated it will endeavor to determine if control functions “are valued” at the organization; whether breaches of policies and controls are tolerated; whether the organization proactively endeavors to identify potential risk and compliance issues; whether supervisors embody the firm’s culture; and whether subcultures that might develop within the organization contrary to the firm’s culture—for example, in branches or on trading desks—“are identified and addressed.”

FINRA likewise indicated it would key in on four areas to assess the effectiveness of members’ supervision, risk management and controls: handling of conflicts of interest, technology (including maintaining effective cybersecurity and data quality), outsourcing and anti-money laundering. According to FINRA, “[w]hile many firms have improved their cybersecurity defenses, others have not—or their enhancements have been inadequate.”

FINRA also noted it has observed “significant operational breakdowns” related to the rollout of new compliance systems. FINRA claimed,

[t]hese breakdowns can arise from coding issues, flaws that prevent the entry of information to facilitate proper implementation of controls and inadequate procedures leading to the suppression and override of automated alerts. This can lead to inadequate retention and supervision of email and other electronic communications, inaccurate position reports and problems with the identification of activity in customer accounts for review, among other things.

Additionally, FINRA said it would review whether firms’ funding plans are adequate in light of their business models. According to FINRA, this is because “[f]ailures to manage liquidity have contributed to both individual firm failures and systematic crisis.” In particular, FINRA noted it would focus on the liquidity planning and controls of high-frequency trading firms.

Finally, FINRA disclosed it anticipates issuing monthly report cards to firms that focus on layering and spoofing. According to FINRA, “[t]he report cards will provide information both with respect to instances where all of the potentially manipulative activity is occurring through the firm and where at least one portion of the activity is occurring through the firm while the remainder is effected outside the firm.” FINRA said it would monitor how firms use this information.

This is the 11th year FINRA has articulated its examination priorities at the beginning of the new year. (Click here to compare this year’s priorities with FINRA’s 2015 priories by reviewing the article, “FINRA Highlights Member Examinations Focus for 2015” in the January 11, 2015 edition of Bridging the Week.)

My View: It is very important that any reports members receive from the Financial Industry Regulatory Authority regarding potential layering or spoofing activity occurring at their organizations be of very high quality. Practically, members will feel obligated to evaluate all if not most all of any situations identified by FINRA as potentially problematic. However, the problem with any compliance report is usefully defining the parameters of the purported bad conduct that is sought to be detected. This involves an iterative process that typically takes time and a fair amount of resources. The securities industry can only hope that FINRA does not overload them with reports of potentially problematic transactions that contain mostly false positives and distracts them from using existing resources to more effectively review ongoing conduct.


Compliance Weeds: The beginning of the yearbefore it gets too busyprovides an excellent opportunity for firms to review all control-group manuals, including compliance and anti-money laundering policies and procedures. Commodity Futures Trading Commission and Securities and Exchange Commission overseen brokerage-type entities are subject to express AML requirements. Included below is a listing of resources published by the CFTC, SEC, the National Futures Association and the Financial Industry Regulatory Authority to assist such firms double check their AML requirements, as well as a link to resources for mutual funds and a recent Financial Crimes Enforcement Network rule proposal to require registered investment advisers to maintain a formal AML program. However, in addition to checking to ensure that applicable policies and procedures comply with relevant requirements, it is critical to ensure that (1) requirements of such policies and procedures are being followed as written, and (2) the responsibility for tasks is assigned to appropriate supervisors. For example, compliance officers might be required by a procedure to assist in helping business line supervisors comply with applicable laws, but they should not be responsible to ensure a firm complies with applicable laws. Moreover, the new year presents an excellent opportunity to test whether control-group software is accurately capturing data from all relevant sources and is utilizing or analyzing such data as expected.

AML Resources:

SEC (for broker-dealers):
SEC: (for mutual funds):
FINCEN (re: investment advisers):
(Click here to also access the article, "FinCEN Proposes AML and SAR Requirements for Investment Advisers" in the August 30, 2015 edition of Bridging the Week.)

And more briefly:

And finally:

For more information, see:

CFTC Proposes a Rule to Permit Foreign Natural Persons to Avoid Fingerprinting:

CME Group Proposes to Toughen Requirements Prohibiting Exchange Access by Persons Subject to Economic Sanctions:

FINRA Will Grade Members on Culture, Supervision and Liquidity Management; BDs Not Managing Spoofing Likely to Get Bad Scores:

FX NDF SEF Approved as SEF by CFTC:

LME Provides 2016 Enforcement Guidelines:

NFA Updates Regulatory Guides to Address New FDM Rules:

Forex Transactions:
Self-Examination Questionnaire:

Paying Salespersons Salary and Discretionary Bonus Is Misleading When Clients Are Told Payment Is Based on Performance Says SEC in Enforcement Action:

Process for SD and MSP Responses to NFA Requests for Additional Information Revised:

Sentinel Management’s Bank Held by Appellate Court to Have Been on Inquiry Notice of Cash-Management Firm’s Misuse of Customer Funds; Demoted to General Creditor Status:

Steven A. Cohen Barred by SEC From Serving as Hedge Fund Supervisor for Two Years for Alleged Supervisory Failures; No Fine Assessed:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of January 9, 2016. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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