SEC Report: Broker-Dealers’ Handling of Material NonPublic Information

The Securities and Exchange Commission, through the Office of Compliance Inspections and Examinations (OCIE), has announced and issued a staff report aimed at aiding broker-dealers in safeguarding confidential information from misuse.

Taken from examinations of broker-dealers conducted by the SEC, FINRA, and the NYSE’s Division of Market Regulation, the report reflects strengths and weaknesses OCIE identified in examining how broker-dealers handle material nonpublic information to prevent improper uses.  Misuses might include insider trading, trading during a tender offer in violation of SEC rules or through issuance of a research report based on  material non-public information.

When facing the challenge of designing their controls, the report may be particularly beneficial to broker-dealers dually-registered as investment advisers or who are closely integrated with an affiliated investment adviser.

Carefully pointing out that no one size fits all, and from a “best practices” perspective, OCIE found two practices among some broker-dealers to be particularly effective. The first involved those included broker-dealers who developed processes that differentiated between types of material non-public information based on the source of information coming from within the broker-dealer or the nature (e.g., transaction type) of the information.  In certain instances, the report notes, ” broker-dealers were creating tailored exception reports that took into account the different characteristics of the information.”

The second practice involves broker-dealers who expanded the scope of instruments that they reviewed for potential material non-public information misuse  by traders.  Included are credit default swaps, equity or total return swaps, loans, components of pooled securities such as unit investment trusts and exchange traded funds, warrants, and bond options.

In addition to defining  many of the sources of material non-public information, the report also provides an overview of broker-dealers’ controls structure and their controls – both in terms of  public versus private side of transactions, and in how firms limit and prevent authorized and unauthorized access (physical and technical barriers) to such information.

A look at SEC litigation releases, in the past few six months alone, show no shortage of cases involving misuse of material nonpublic information being either filed or settled.   As the report states, look for OCIE to continue reviewing broker-dealer practices in these areas in future examinations.

Author: Dexter Johnson

The author is a an attorney who for the past 14 years has concentrated his practice in representing, successfully, investment advisers, broker-dealers, corporations and individuals who are subject to SEC, FINRA, State or other regulations and who may be the subject of regulatory examination, review or investigation. He formerly worked at the SEC. His regulatory and litigation experience has encompassed virtually every type of securities issue in the industry. He has also negotiated favorable outcomes in many of these matters for his clients.