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To what extent is a broker-dealer responsible for the actions of its customers?
This is a recurring question for the compliance and trade surveillance function.
Is the company an agent and cannot know the minds of its customers and therefore is not responsible for the intentions and context of customer-initiated trades?
Or is the company the “gatekeeper” to the financial markets and therefore responsible for the fidelity and impact of the trading it facilitates on behalf of customers in those markets?
Ian Hawkins, Nasdaq
Over the last five to 10 years, there has been a major shift in the courts toward broker-dealers as gatekeepers. A recent order by a US federal judge in the Harrington Global Opportunity Fund Ltd. case. v. CIBC World Markets, Inc. et al. doubled the requirement for businesses to exercise discretion in accepting and processing orders on behalf of customers.
The case itself involves allegations of spoofing, a form of market manipulation in which traders place orders they do not intend to execute, and naked short selling, the practice of selling stocks that an investor neither owns nor has borrowed. The defendants argued that the trading was initiated and executed by their customers and that they could not be held responsible for facilitating these trading instructions and for any subsequent impact of these orders on the market.
However, in a rebuttal, the judge in the case noted that broker-dealers “continue to be responsible for ensuring that their customers’ order flow… complies with all applicable rules, regulations and laws and for detecting and preventing manipulative or fraudulent trading…” oversight and control of the company.”
The court viewed brokers as gatekeepers of the markets who have a duty to monitor, monitor and prevent their clients from engaging in fraudulent trading behavior. It goes on to say that if a broker-dealer fails to monitor its clients’ trades and is “reckless in failing to know that the trades executed at the direction of its clients were manipulative,” the broker may be held “in the first place.”” liable.
The court’s opinion on this matter seems clear.
This is also consistent with previous regulatory measures that adopted a similar approach. For example, in a recent article we highlighted the circumstances of FINRA’s lawsuit, Case ID 2017054491001, against a US-based investment firm. The important events of this case were:
- The company provided electronic trading customers with access to a trading platform that routed their orders to other broker-dealers for execution.
- The Company believed that the burden of screening these trades for potentially manipulative activity rested solely with the executing broker-dealers.
- FINRA argued that “the firm mistakenly believed it had no obligation to review these trades for potentially manipulative activity of any kind.”
- FINRA argued that due to this lack of control, the company failed to detect potential layering activity by an institutional e-commerce client across different exchanges.
- The Company accepted and consented to a FINRA order (without admitting or denying the findings).
Given these and similar regulatory measures, it is critical that a broker-dealer’s risk assessment includes a review of all channels through which it is directly or indirectly involved in transmitting customer orders to a trading venue – and that it has checks and balances in place Monitoring is in place to monitor this flow and identify potentially abusive trading.
Ian Hawkins is Head of Nasdaq Trade Surveillance Advisory Services.
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