Use Caution When Overriding System Controls

What’s Happening:

Recently the SEC issued an action against a firm for violating the market access rule in connection with a trading incident that resulted in the erroneous executions of options contracts. The Market Access Rule (SEC Rule 15c3-5) requires broker-dealers with market access to establish, document and maintain a system of risk management controls and supervision processes to limit financial exposure and ensure compliance with all regulatory requirements. 15c3-5 controls are ideally built into business processes, and are supported by systematic and operational controls with real-time alerts & monitoring.

The firm mistakenly sent 16,000 mis-priced options orders to various option exchanges before the start of regular market trading. Although the firm managed to stop the creation of orders and began canceling the erroneous ones sent for execution, shortly after the market opened approximately 1.5 million of the orders were still executed.

According to the Order, the error was the result of several failures:

• During pre-market hours the firm used “unreasonably wide” price checks for its options orders – using appropriate price bands similar to those used during market hours would have allowed detection of erroneous orders
• The firm’s control staff repeatedly lifted circuit breakers during the pre-market and for two minutes after the open, causing the breakers to miss blocking the orders;
• The firm’s policies relating to the manual lifting of the circuit breakers were not explained and /or fully understood by the responsible employees;
• The firm had inadequate policies and procedures with regard to software changes; and
• Inadequate risk management controls and supervisory procedures relating to the prevention of orders that exceeded the firm’s pre-set capital threshold.

“Firms that have market access need to have proper controls in place to prevent technological errors from impacting trading,” said Andrew Ceresney, Director of the SEC Enforcement Division.

What Your Firm Should Do:

• Ensure the Firm’s Written Supervisory Procedures and Continuity Education Program incorporate instructions and training for operating trading systems controls and review them regularly.
• Ensure adequate supervisory controls are place for trading systems.
• Evaluate the adequacy of the Firm’s Software Development Life Cycle (“SDLC”) processes, particularly its change controls policies and procedures for its trading systems.
• Assess the Firm’s ability to perform dynamic capital utilization and risk calculations
• Ensure capital utilization threshold controls can automatically stop trading and notify relevant personnel.
• Perform regular reviews the reasonableness of capital and credit controls applied to internal desks and client accounts.
• Ensure appropriate kill switch procedures are part of in place and regularly tested, by control personnel.

How Oyster Can Help:

Oyster has provided consulting services to well-known and respected High Frequency Traders and automated trading firms. We have experience with high profile 15c3-5 assessments, certifications, and independent consultant engagements on both FINRA and SEC matters. Oyster can perform a comprehensive assessment of your 15c3-5 compliance program, your technology platform, risk management and supervisory practices.