SEC Exam Priorities – Trade and Transaction Reporting

By Jeff Gearhart, Frank Childress and Jose Fernandez

SEC exam priorities trade reporting

Capital markets are rapidly evolving and the rules are changing. Technology innovations are creating a faster trading environment and regulators are focused on trade reporting and trade desk compliance. Each year the Securities Exchange Commission (SEC) publishes its exam priorities for the coming year. In this week’s Oyster Stew podcast, Oyster’s Capital Markets experts Jeff Gearhart, Frank Childress and Jose Fernandez share their thoughts on the exam priorities and what is happening in the industry around broker-dealer trading practices including:

  • Rule 15c2-11
  • Reg SHO
  • Reg ATS and filing requirements

Oyster Consulting’s experts use their deep regulatory, operations and trade and transaction reporting experience to help firms meet trade reporting obligations, uncover efficiency opportunities and develop a comprehensive control environment. When it comes to trade reporting, Oyster will review your firm’s process for creating and submitting trade reports, including a review of written supervisory procedures, organizational structure, supervisory controls, regulatory and internal audit findings, system documentation and previously used test scripts. Trade reporting is becoming more complex – get the expertise you need.

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Transcript provided by TEMI

Bob Mooney:  Welcome to the Oyster Stew Podcast. I’m Bob Mooney, General Counsel for Oyster Consulting. Each year, the SEC publishes its exam priorities for the coming year. Join us for today’s podcast as Oyster Consulting’s Capital Markets experts, Jeff Gerhart, Frank Childress, and Jose Fernandez share their thoughts on the priorities related to broker-dealer trading practices, including Rule 15c2–11, Reg-Show, Reg ATS and filing requirements. Let’s get started, Jeff.

Jeff Gearhart:  Thanks Bob. We’re here today to talk about the SEC priorities, particularly the broker-dealer trading practices. I think it was an interesting selection of priorities because we know that they’re going to remain diligent on Best Execution, Market Access and all the regular topics as well. But these are the ones they chose to highlight for this year. Frank, Jose, you guys were both at some recent industry events. Do you have any perspective on what the SEC might be talking about around 15c2-11 both from their priorities and maybe just any ideas on general updates?

Frank Childress:  Sure. I’ll kick that off, Jeff. It’s interesting. The SEC’s looked at 15c2-11, which is essentially a quoting reg. And they’ve looked at it on both the equity and fixed income side in recent years. I’ll speak to the equity side and then flip it over to Jose. With respect to fixed income on the equity side, the rules changed in late 2020, so almost exactly three years ago, to create the OTC market. So this applies really to non-listed securities, since listed securities are automatically quoted on their various exchanges. But the OTC markets, in conjunction with the SEC, work together to create a model where they require greater financial disclosure, disclosure for the equities within OTC markets within the issuers.

And to the extent that they don’t comply with those financials, they effectively get bumped off from a quoting montage, so they’re no longer eligible to be quoted. They go to less transparent markets like the grays. So, this rule effectively largely eliminated the rule for wholesalers to fill out the 15c2-11 form, because OTC markets took it upon themselves to serve as, effectively, a warehouse for those financials, and that they would be the entity for publishing the quotes. So I found it a little curious why the SEC would identify this as a “priority” with respect to wholesalers in the equity marketplace. So it’ll be interesting to see as that develops, and I’ve talked to some wholesalers about this as well. So almost exactly a year ago, the SEC reached out to attempt to apply this longstanding equity quoting rule to fixed income securities because they were considered on an OTC market. So I’ll let Jose kind of explain how that was received and how they managed through that. So, Jose, I’ll turn it over to you on the fixed income side.

Jose Fernandez:  Thank you. This is an interesting one. So this is one whereby the rule itself dates back in 1971. It’s been in place for quite some time, and after nearly 50 years, they’re looking to apply this to the fixed income markets. So back in 2020, there were some amendments that were made to “modernize,” as the term is used, 15c2-11 to account for advances in communications and technologies and such. Obviously, the industry had some pushback, and, after several extensions, it was expected to start being enforced, again in the fixed income markets, starting January 4th, 2025. However, through continued efforts with the market participants and comment periods, and leveraging a lot of the trade groups that are out there, and associations that provide legislative and advocacy for a lot of the member firms, they were able to provide some thoughts around how this is not applicable to certain parts of the fixed income markets, and specifically 144a securities.

And, oddly enough, as I was at the BDA National Fixed Income Conference in DC, they were meeting to review and approve these amendments. They came back and I think they officially published something on October 30th, I want to say, basically excluding 144a securities in the fixed income space from this requirement. Now, that is obviously a win for the industry from the standpoint of, that is the one area that seemed to get a lot of attention from the industry.  One thing to note is that the exceptions that were approved do not cover certain fixed income securities that the market participants need to be aware of. And specifically, just as a few examples, are those that are issued under Regulation S, section 4.A.2, section 4.A.1, and/or Regulation D.

So, those are examples where the exemption will not cover. However, they will be covered under the relief order, which again extends to about January 2025, I believe, and it should be duly noted. The other thing to consider here is that there are certain securities which may still be in focus for this, and specifically around the Safe Harbor of Rule 144A, and that is equity securities that are sold in compliance with the Safe Harbor. So again, I want to point out that the order was for fixed income securities. So, pursuant to an exemption from Regulation 144A. However, it does not cover equity securities that are sold under that Safe Harbor as well. So, still more to come, I’m sure, on this. I’m sure the market participants will still continue to provide feedback and try to get to a place where the rule, if it’s going to be applied to fixed income securities, is applied in a manner that makes sense. And one of the terms or phrases that the regulators seem to be using these days is one that is not too onerous on the industry. And so, more to come on that, on the fixed income side. But it is definitely interesting that they took a rule that was 50 some years old and are now looking for applicability to the fixed income based off the OTC, over the counter definition.

Jeff Gearhart:  An interesting point to add here, there’s a no action letter out there.  But I’m aware of several instances where, during a regularly scheduled exam, FINRA commented on the lack of WSPs for 15c2-11 covering fixed income products. So it’s probably relevant for firms to just throw a section in there and determine how applicable it is to them, or at least say that it’s not applicable because, despite the no action letter, they’re making some comments on it.

Frank Childress:  So, as we indicated upfront, it’s a little unclear within the SEC priorities letter, whether they’re looking at equities or fixed income. They do reference specifically wholesale market makers, which traditionally feels like the equity marketplace. So, I guess everybody should be aware and should be thinking about this as they get into their SEC exams.  But they specifically call out including quote generation, order routing and execution practices, market data ingestion, and regulatory controls and risk management. So, regardless of equity or fixed income, certainly something to be aware of.

Jose Fernandez:  So, one of the other topics, if I can switch gears a little bit, still kind of in that equity space, is Reg SHO, which again, made the list on a continued focus of the SEC. I think, if I remember it serves me right, I think it was 14 or so, Acceptance, Waiver, and Consents (AWCs) between January 2022 and September of 2023, often resulting in significant dollars as far as fines and sanctions. SEC mentioned a focus on aggregation units. Any insight there?

Jeff Gearhart:  Yeah, I can expand a little bit on that. If you recall from Reg SHO, there’s a requirement for a firm to determine their net position in or in order to mark a sale transaction as a long sale short sale unless you’re under the market making exemption. Well, for large complex organizations that can be quite a challenge. An aggregation unit actually gives you the ability to define a unique trading group and determine your net position based on that, what we’re going to call an aggregation unit. So it makes a lot of sense. It can be really efficient. But the key is, to qualify, a firm must first have a written plan or organization in place to define that trading unit. That includes the objective and supporting why it makes sense for them for that group to be separate from the other groups, if, and when a firm does that, whenever they’re doing trading, they just focus on that individual group to determine their net position.

Now, a couple requirements that are key here, all traders that are within that unit must be trading the same strategy or have the same objective. Also any individual trader assigned to that unit, that can be the only unit they’re assigned to. So, makes sense. But you can easily see what could go wrong here. We’ve all been around trading shops, and they may, they make sense at the beginning when you set these up, but if you don’t maintain the definition of the, the aggregation unit, clearly make sure that the people in there are trading within the strategy. Make sure if a trader switches desks or, or changes their strategy, they get reassigned. There’s the potential to corrupt the aggregation unit, if you will, which then would become a violation of Reg SHO, because you wouldn’t be determining, be determining your net position. So it can be complicated. This is a way to simplify it, but you need to make sure that you’re, you’re keeping that unit well-defined, you know, periodic reviews. I think it could easily be incorporated into a review of risk limits trading mandates any other type of normal committee review or process review. So I can see why the SEC’s focused on here, because it does have the potential, like anything else to be not, you know, in, in the front of your mind. And changes happen. You don’t, and you don’t keep it current.

Jose Fernandez:

Yeah, that’s great insight. Now what about the, I believe, there’s some locate requirements. What’s the focus there?

Frank Childress:

Yeah, so the locate requirements, and this ties right into FINRA’s 2023 examination and risk monitoring program requirements. And they do a good job of outlining some of the issues related to locates, but sort of the old practice of just having a firm’s name documented within a locate is not going to apply. You need greater detail on what the locate is, where the locate is coming from. And they also, within FINRA, does a nice job within their findings and effective practices with really laying out where they’re targeting. So within their findings, they found that, sort of impermissible use, reuse of locates. So there’s FAQs that address this, that are certainly available to you, but the sort of effective practices would require the supervision of any kind of reuse of locates. And that includes developing appropriate policies and procedures to make sure that you’re in guidance with what they refer to as question 4.40.4, the Reg SHO, SEC’s Reg SHO FAQs. So, using hard blocks and on threshold securities are easy to borrow lists as limits for reuse, and to make sure that you have systems checks to allow reuse only in securities that are deemed easy to borrow.  So these are just standard blocking and tackling documentation that you need to have in place. Both FINRA and the SEC do a pretty good job within their FAQs, and in FINRA’s report, on giving you some good guidance on how to manage locates.

Jeff Gearhart:  Frank, I like the term blocking and tackling. This is pretty basic. Firms should have this embedded in their technology in their OMS. It should be normal process.

Frank Childress:  I think virtually all OMS at this point have the ability to capture that and document it. And so, if you’re not already working with your OMS to make sure that that’s in place, that’s something you should think about.

Jeff Gearhart:

From my review of prior AWCs, things of that nature where things go wrong there are usually a change management type event where they may be updating the technology, and sometimes then a code could change and, and maybe a short sale’s not correctly flagged. So then, the technology control doesn’t automatically require the locate or the locate information, some basic things like that. So focusing on change management controls, I think is key on this topic. Otherwise, it’s really not something that you should screw up. And it certainly is not something you want to make a mistake on because it’ll get expensive. 

So, now we come to the last topic we wanted to address within the SEC priorities. The SEC notes a focus on Reg ATS (Alternative Trading System) and filing requirements. You want to provide a little background on this. Certainly, we continue to see somewhat of a proliferation of ATSs, both on the fixed and income and equity side. You want to elaborate about what the SEC is looking at?

Jeff Gearhart:  Sure. The number of ATSs does continue to increase and particularly, digital assets, things of that nature. I think as of the end of September, there were 69 registered with the SEC.  If you’re ever curious, the SEC puts out a monthly list of all the ATSs, <laugh> if you want to see what’s going on out there. But keep in mind, with Form ATS, it’s a notification that you file with the SEC.

So you’re not asking their approval to run the ATS, you’re filing a form with them, telling them you are going to start an ATS. And, that form has to give certain information, information about the operation, the order entry procedures, the display of orders, and quotes, the role of any entity that’s associated in supporting it. So basically, it’s close to a business plan. Maybe not the financial aspect, but it’s a business plan on how the ATS works. And when you think about running an ATS, remember all the principles of fair trade are still in place. You have to run the ATS, the quoting, the order matching, everything along those lines so that it’s fair for everyone, and it doesn’t incent one client over another or anything of that nature before form ATS or form ATSN if you’re going to trade NMS stocks, is required before you start operations.

And it’s also required whenever you’re going to make a substantial change to the operation of the platform. And typically the form has to be filed 20 days before a material change in the operation. And then if you find at some point that the form you have on file is not accurate, or it needs to be amended, you have to file that within 30 days after quarter end. So, to make sure you’re meeting the requirements and the form ATS you have on file with the SEC is accurate, you need to implement that into the regular review of your operations. Really important here, you need to make sure your disclosures are clear for the clients or counterparties that are using the platform. Make sure they’re accurate, and they truly define how the ATS is working. And if you have key vendors or key counterparts or key partners that are operating on the platform, you need to make sure those are clearly disclosed.

There was a recent AWC that actually cited a firm for exactly that, where they weren’t properly disclosing all the key interested parties in the platform. Now, I think this is also an important point because we’re only talking about Form ATS here, but remember, an ATS has to be sponsored by a broker-dealer, and a broker-dealer has a membership agreement with FINRA or some type of guiding document. So anytime you’re making a substantial change, that very likely could require a change to your membership agreement. So you might have to go through the CMA process. And, also keep in mind that if you have a very successful ATS, you’re probably going to bring in Reg SCI and some other rules around the stability of the platform, making sure it’s consistently there and available to clients, you have an adequate business recovery plan, things of that nature.

So I can see again why the SEC is focusing on this, given the proliferation of ATSs, the number and types of assets that are traded on them.  They want to make sure there’s not a disruption to the marketplace. And this is a case where firms just need to remain diligent. I mean, it is a trading platform. It’s not an exchange, but you need to make sure that it’s being made available to clients so they can trade when they need. You could include it in your Market Access reviews, you could include it in annual certifications or new product business committee changes, any normal standard process that might pick up oversight of this. Keep in mind, Form ATS is for a change in material business. This is different than the form ATS-R, which you just have to file monthly, which shows volumes and activity on the platform.

Jose Fernandez:  Yeah, Jeff, I was just going to say, one thing to add, and you touched on this briefly when you mentioned that one of the requirements is ATS, is that you do not prohibit or limit access to, in a discriminatory manner. And so this all comes under Rule 301(b)(5), and within the Reg ATS, which is otherwise known as the Fair Access rule. But one other point I want to make with regards to that particular provision is that a firm, once they exceed the significant percentage of overall trading, the 5%, they have a requirement to have written standards for granting access for trading on the ATS. So I think, as you were mentioning AWCs, kind of came to mind is one whereby the findings were that they failed to establish written standards for granting access to the ATS. So, it kind of speaks to the granularity in which this particular rule and some of the provisions within it outlined, but it’s certainly worth noting that as with anything else, you have written supervisory procedures; you have a process. All that needs to be documented. Otherwise, it kind of opens up the firm for potential scrutiny from regulators or other bodies. So I just wanted to point that out.

Jeff Gearhart:  So, those are the priorities the SEC published recently, and I think they continue to be focused on a lot of other topics such as Best Execution and Market Access.  In our role with Oyster as consultants, we are actively engaged with a lot of our clients and get direct feedback on the questions they have from the SEC, and/or FINRA, whether it’s a unique, especially focused review or just a standard review. So we see what’s happening and we can help you respond to these questions, set up best practices, and hopefully not, but remediate any issues that come up. Feel free to give us a call, even if you just want to chat on the topic.

Bob Mooney:  Thanks everyone for listening. If you’d like to learn more about our experts and how Oyster can help your firm, visit our website at If you like what you heard today, follow us on whatever platform you listen to and give us a review. Reviews make it easier for people to find us. Have a great day.

About The Podcast Speakers
Photo of Jeff Gearhart

Jeffrey Gearhart

Jeffrey Gearhart is an intuitive, analytical leader with over 30 years of experience in banking and capital markets businesses. Prior to joining Oyster, he held senior leadership roles with The Bank of New York Mellon, including business line COO, CFO, business development and relationship management.

Photo of Frank Childress

Frank Childress

Frank Childress is an engaged and respected Financial Services professional with over 35 years of industry experience. Frank has extensive expertise in Equity and Fixed Income Trading, Equity Market Structure, and Capital Markets Products for retail distribution.

Photo of Jose Fernandez

Jose Fernandez

Jose’s executive experience includes responsibility for the overall coordination and ongoing improvement of operational support functions and processes including Client Onboarding, Operational, Counterparty and Market Risk, Regulatory Compliance, Audit, Profit/Loss management and reporting, Vendor Management and Technology.

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