Avoid Regulatory Action with Broker-Dealer Compliance Software


In a landscape rife with legal obligations, few financial firms are as heavily regulated as broker-dealers.

From transaction monitoring and conflict management to complex customer protection rules, the resources needed to maintain compliance are significant—but not as high as the costs of being found non-compliant.

In this article, we’ll look at the regulatory landscape for broker-dealers and what firms can do to stay on top.


What Does a Broker-Dealer Do?

Broker-dealers are buyers and sellers of securities and distributors of other investment products such as mutual funds, variable annuities, and insurance products.

They perform two roles:

  • As dealers, they act on their own behalf, trading securities for their firm’s account.
  • As brokers, they buy and sell securities on behalf of their clients.

Broker-dealers fulfill several important functions, including promoting the flow of securities on the open market and providing liquidity to ensure the continued success of securities markets.

How are Broker-Dealers Regulated?

Broker-dealers are among the most heavily regulated financial institutions. Most are regulated by:

  • The Securities Exchange Act of 1934
  • The Securities Exchange Commission (SEC)
  • The Securities Investor Protection Group (SIPC)
  • The Financial Industry Regulatory Authority (FINRA)
  • The Bank Secrecy Act (BSA)
  • The Commodity Futures Trading Commission (CFTC)
  • State-level ‘blue sky’ laws

These regulations cover various functions, including trading activity, anti-money laundering (AML) and anti-fraud, customer protection, and managing conflicts of interest. The result of all these different regulations is a spider’s web of requirements that broker-dealers must adhere to strictly. Failure to comply can lead to substantial fines from regulators.

In the last year alone, several high-profile broker-dealers have been fined huge sums for non-compliance. In September 2020, one of the largest electronic broker-dealers was fined a combined $38 million by the SEC, FINRA, and the CFTC) for failing to properly implement anti-money laundering (AML) processes.

Further, recent enforcement action by the SEC and FINRA has demonstrated that it’s not only large firms that need to be concerned about compliance. Small and medium-sized broker-dealers increasingly face enforcement action for non-compliance, often costing millions of dollars.

Net Capital Requirements for Broker-Dealers

The SEC’s Uniform Net Capital Rule regulates broker dealers’ ability to meet financial obligations to their customers and creditors. To achieve this, the SEC created Rule 15c3-1, which requires:

"[...] every broker-dealer to maintain at all times specified minimum levels of liquid assets, or net capital, sufficient to enable a firm that falls below its minimum requirement to liquidate in an orderly fashion."

Source: Net Capital Requirements for Brokers or Dealers SEA Rule 15c3-1, FINRA, 2014

This requirement aims to ensure broker-dealers maintain a ‘cushion’ of liquid assets to repay any unsecured debts in the event they are forced to liquidate. There are two routes for firms to meet this requirement:

  • The Basic Method measures liquid assets against the firm’s unsecured indebtedness.
  • The Alternative Method measures liquid assets against obligations owed to the firm by customers.

In both cases, broker-dealers must calculate their net capital at all times, along with a further ‘cushion’ of liquid assets to pay continuing operating costs if the firm had to liquidate. This secondary requirement is aimed mainly at small broker-dealers, as they are more prone to liquidation than larger firms.

Keeping track of both these factors requires an ongoing calculation that can be complicated and resource-intensive. Again, failure to keep on top of these requirements can lead to large fines.

What is SEC Rule 15c3-3?

Enacted in 1972, SEC Rule 15c3-3 aims to protect client accounts at securities brokerage firms, including broker-dealers. The rule determines how much cash and securities a broker-dealer must hold on behalf of clients in separate, protected accounts. This ensures clients can withdraw most of their holdings on-demand, even if a broker-dealer becomes insolvent.

At least once each week, firms must total up the cash and security they owe to customers and that customers owe them. If the amount they owe is higher than the amount customers owe them, the firm must ‘lock up’ a portion of the amount in a Special Reserve Bank Account for customers’ benefit. For larger firms, the amount held in this account can reach billions of dollars, and it can’t be used for any purpose.

As you’d expect, the calculation required to comply with Rule 15c3-3 is far from simple. It includes complex adjustments based on derivatives, lending arrangements, and risk levels assigned to different asset classes that can substantially change the outcome of the calculation.

Broker-dealers that fail to comply with Rule 15c3-3 can face huge fines. In 2016, investing giant Merrill Lynch was fined $415 million for breaching several requirements of the Securities Exchange Act, including 15c3-3. Fines to small and medium-sized firms are less astronomical but still reach multi-million dollar figures.

Broker-dealers that identify non-compliance issues with Rule 15c3-3 (or any other section of 15(c)(3), A.K.A. the Customer Protection Rule) can self-report to the Division of Trading and Markets and the Division of Enforcement of the U.S. Securities and Exchange Commission under the Customer Protection Rule Initiative. Similar to pleading guilty in court, these firms receive favorable treatment if enforcement action is warranted.

Compliance Considerations for Broker-Dealers

With such a complex regulatory landscape, broker dealers’ compliance programs need to run like a well-oiled machine. From tracking a huge number of separate deals for conflicts, AML, anti-fraud, and more to ensuring compliance with customer protection regulations, firms can’t afford to cut corners on compliance processes.

Some important considerations include:

  • Ensuring compliance teams are adequately funded and empowered.

Compliance teams inform and guide a firm’s culture to ensure it meets all its regulatory requirements. To do this, broker-dealers must invest adequate resources to ensure their compliance teams aren’t overly stretched and unable to keep up with the transactional component of their roles.

In addition to funding, compliance leaders should have an open communication channel with the firm’s leadership to provide regular updates. If a compliance leader believes there is a cultural issue to be changed, they should be empowered to investigate and take action as needed. This preventative action may incur a temporary cost but should be weighed against the longer-term risk of non-compliance and regulatory action.

  • Managing risk.

FINRA has stated its examination process is “risk-based,” both in terms of how frequently a firm is examined and the focus of each examination. To understand which business areas are most likely to be assessed, broker-dealers should have strong internal risk assessment and management systems in place.

Ultimately, broker-dealers must meet all their compliance requirements. However, they should pay particular attention—and apply their most stringent controls—to business activities that pose the highest risk of non-compliance action.

  • Putting effective transaction monitoring in place.

Transaction monitoring lies at the heart of broker-dealer compliance. To maintain compliance, firms must continually monitor transactions for a host of issues, including:

  • Suspicious Activity Reporting (SAR)
  • Anti-money laundering (AML)
  • Anti-fraud
  • Conflicts of interest
  • Ultimate Beneficial Ownership (UBL)

Transaction monitoring is also a key component of employee surveillance, which is essential to detect and prevent illegal activity.

Of course, achieving thorough transaction monitoring isn’t easy. Historically, it required compliance professionals to complete an endless and laborious monitoring process that slowed down trades and often missed critical non-compliance issues.

Thankfully, modern compliance technologies can automate transaction monitoring, completing assessments in seconds and enforcing compliance requirements regardless of transaction volume.

Protect Your Firm with Broker-Dealer Compliance Software

Clearly, compliance management is far from straightforward for broker-dealers.

With multiple regulatory frameworks and thousands of separate requirements to track, manual investigations are no longer sufficient to ensure compliance. And, with non-compliance penalties routinely hitting millions of dollars, failing to meet requirements isn’t an option.

MCO helps broker-dealers manage, track, and administer their compliance programs, helping to identify illegal or non-compliant activity and meet regulatory requirements. Our solution helps firms to manage FINRA outside business activities, employees authorizations, registrations & licensing, employees personal trades and more with:

  • A thoroughly integrated platform that monitors compliance across all systems.
  • Centralized data that makes it easy for compliance teams to identify and investigate issues.
  • A scalable, modular approach that fits your firm's requirements.
  • An intuitive, easy-to-use interface that boosts efficiency and engagement.

Right now, MCO helps 400+ customers across 85 countries monitor, identify, and resolve compliance issues across their entire organization. Our solution enables broker-dealers to gain greater control and transparency, reduce risk, and ensure compliance across its entire regulatory landscape.

To see how the MyComplianceOffice platform can benefit your firm, arrange a free demo.