Broker-dealer update: Key debates shaping 2015

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BrokerDealer OutlookThe major regulations that followed the 2008–2009 recession are largely in place, but there is still uncertainty surrounding the implementation, integration and possible refinements of those regulations. Many broker-dealers and other financial services professionals have had difficulty meeting the deadlines, and the industry will likely continue to face challenges, including a changing landscape, as requirements are sent back to regulators for further interpretation.

The high-frequency trading debate rages on With the impact of high-frequency trading (HFT) still up for debate, regulators continue to look for any potentially unfair advantages, with the intent of protecting smaller broker-dealers that might not be able to make major technology investments. The SEC has taken several steps over the past year to carve out a more level playing field by issuing guidance on fairness within the market. The guidance has not been as robust as smaller broker-dealers would like, but it gives some indication of regulators’ goals to protect those who might be negatively affected by technology disadvantages. The broker-dealers that made major technology investments are not necessarily ahead, however — future regulations are probable, and these broker-dealers (and their clients) may still end up paying for unnecessary or obsolete technology.

OTC derivatives The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) mandates that “sufficiently liquid and standardized derivatives transactions will be subject to central clearing requirements, and many of those will be required to be executed on new electronic trading platforms,” known as swap execution facilities (SEFs).1 According to the Securities Industry and Financial Markets Association (SIFMA), some derivatives will remain in the over-the-counter (OTC) category, which means their terms will be negotiated between two parties, while others will remain unclear. Examples of derivatives affected by the new swap regulations include interest rate swaps, credit default swaps, nondeliverable FX forwards, swap options and equity total return swaps.2

The SEC and the Commodity Futures Trading Commission have finalized several rules to increase transparency and reduce risk in the derivative markets, including:
  • Reporting swap transactions to a swap data repository
  • Clearing sufficiently liquid and standardized swaps on central counterparties or designated clearing organizations
  • Trading standardized swaps on SEFs or designated contract markets
  • Setting higher capital and minimum margin requirements for uncleared swaps3

SEC Rule 17a-5 amendments Carrying broker-dealers have incurred greater-than-expected costs in their implementation of Rule 17a-5 amendments related to internal controls over compliance, which enables them to issue a compliance report for the year-end. SIFMA has expressed concern that although certain amendments are effective, they still lack clear guidance related to the scope of the assessment, of internal control over compliance, as well as the evaluation and consideration of events causing noncompliance. SIFMA has formally asked the SEC for clarity in these areas; however, it is uncertain when and if the SEC will provide any additional guidance. Noncarrying broker-dealers are also affected: They must issue a year-end exemption report related to compliance with their exemption under Rule 15c3-3. They are also required to disclose all exceptions. These broker-dealers are seeking clarity as to what constitutes an exception, because accepted industry practices may not be consistent with SEC definitions. In addition, under the new amendments, both carrying and noncarrying broker-dealers must engage a PCAOB-registered public accounting firm to report on the compliance or exception report and file the report with the commission.

New revenue recognition rules On May 28, 2014, the FASB and IASB issued ASU 2014-09, which converged guidance on recognizing revenue in contracts with customers. The objective of the new guidance is to establish requirements for reporting useful information to users of financial statements about the nature, timing and uncertainty of revenue from contracts with customers.4 For public entities, the amendments are effective for annual reporting periods beginning after Dec. 15, 2016. The new standards take effect for private entities one year later.

While principal transactions and securities lending activities are not addressed in the new rule, the amendment includes guidance on:

  • Trade execution for customer orders
  • Custody and related services
  • Investment research or soft dollar arrangements
  • Securities underwriting
  • Wealth and asset management
  • Advisory services (e.g., M&A)

Firms should start planning now for the new standards. Broker-dealers need to assess the overall effect of the new regulations on their operations and business processes, in addition to considering the documentation and systems needed to support accounting and reporting under the new standards. A cross-functional team comprised of accounting, IT, legal and other professionals may speed implementation. Broker-dealers also need to decide how they will communicate the impact of the new guidance on stakeholders.

There is currently limited guidance on how to apply the new standards, but help is on the way. The AICPA has 16 industry groups working on sectorspecific guidance, including the Brokers and Dealers in Securities Revenue Recognition Task Force. The work of the FASB-IASB’s Joint Transition Resource Group for Revenue Recognition may provide additional help.

Cybersecurity Thanks to the numerous high-profile Internet security breakdowns in 2014, cybersecurity is top of mind for consumers, as well as a critical operational concern for broker-dealers, banks and other industry players. Financial services companies can’t afford to wait to develop and implement strengthened cybersecurity policies and IT defenses. In a recent Investment News survey of independent broker-dealers, 77% of the nearly 40 respondents said they plan to boost spending on R&D in 2015 — including ways to protect themselves from cyberattacks — compared with 58% in 2014. In addition, average spending will grow 13% at the 24 firms that provided a dollar figure, with an average projected spending of $3.7 million in 2015, versus $3.28 million in 2014.5

SEC exam priorities Broker-dealers are now subject to SEC examination under the National Examination Program (NEP). The NEP’s priorities address issues that span the entire market, as well as issues that relate specifically to particular business models and organizations. Overall, the SEC considers core risks to be sales practices, fraud, supervision of third parties, trading, internal controls, financial responsibility and antimoney laundering measures. For 2015, the SEC identifies new and emerging issues that will be included in future examinations:

  • Retail investors. To further protect retail investors, the SEC is looking at products that may have previously been aimed at more sophisticated investors. These products could include private funds, low-liquidity investments and structured products. The SEC is also taking a much deeper look at the risks caused by information, advice, products and services aimed at investors facing retirement.
  • Market-wide risks. The SEC is looking at structural risks that go far beyond single brokerdealers. They will be examining clearing agencies (as required by the Dodd-Frank Act), looking at cross-industry cybersecurity controls, assessing equity order flow and evaluating compliance with SEC policy division regulations.
  • Data analytics. Because of the SEC’s enhanced ability to collect and analyze large amounts of data, broker-dealers can expect a much closer examination of data to identify those potentially engaged in illegal activity.

FINRA exam priorities On Jan. 6, 2015, FINRA released its 2015 Regulatory and Exam Priorities Letter.6 The letter addresses what FINRA considers to be the issues that have the potential to negatively affect investors and market integrity. The letter identifies five key areas that will be under close watch in 2015 examinations of broker-dealers:

  1. Aligning firm interests with customer interests
  2. Ethical behavior
  3. Supervisory and risk management systems
  4. “Novel” products and services
  5. Conflict of interest management

Further, FINRA identifies specific concerns like alternative mutual funds, cybersecurity, senior investors and investor wealth events. FINRA also noted that it intends to continue focusing on high-risk brokers and those who prey on vulnerable investors.

Looking forward While 2015 is shaping up to be a year of less dramatic change, the challenges and refinements to new regulations will nonetheless significantly affect the broker-dealer industry. Broker-dealers should act now to address areas such as cybersecurity and potential NEP exams, because these changes will ultimately improve their business and reduce risk.

Contacts Mark A. Ramler
Audit Partner
Financial Services
T +1 212 624 5206

Jack Katz
National Managing Partner, Financial Services Industry Group
Financial Services Global Leader
T +1 212 542 9660

1 Overview: OTC Derivatives, Securities Industry and Financial Markets Association. Visit derivatives/overview for details.
2 Ibid.
3 Ibid.
4 “Why did the FASB issue a new standard on revenue recognition?” Financial Accounting Standards Board.Visit for more information.
5 Hanson, Joyce. “Cybersecurity a major priority in independent broker-dealers’ 2015 tech budgets,” Investment News, Sept. 14, 2014. Visit for more information.
6 “2015 Regulatory and Examination Priorities Letter,” Financial Industry Regulatory Authority, Jan. 6, 2015. Visit for more information.

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