The Securities and Exchange Commission set aside a determination by the Chicago Board Options Exchange, Inc. that Electronic Transaction Clearing, Inc., and two of its principals, Kevin Murphy and Harvey Cloyd, Jr., failed to apply its customer identification program to individuals trading on behalf of two omnibus accounts; failed to apply margin rules to the same traders; and failed to implement adequate surveillance tools for identifying suspicious activities of its customers.
CBOE previously filed charges in 2011 against the firm, the two principals, and the firm’s chief compliance officer and anti-money laundering compliance officer claiming that, between December 2009 and July 2010, the firm failed to comply with the CIP rule and margin requirements in connection with the multiple individual traders. (The CIP rule references a requirement under law and of the Financial Crimes Enforcement Network of the US Department of Treasury that broker-dealers, as well as certain other financial institutions, must obtain, verify and record certain information that identifies each person who opens an account; click here for more information related to requirements of broker-dealers.)
The BCC also found that the firm failed to have adequate surveillance tools in 2010 because for a portion of the year, it temporarily de-activated its electronic monitoring system for potential wash sales and other possible manipulative activity. The BCC identified other violations too (i.e., the failure to conduct an independent audit of its AML program in 2009 and the failure to timely close out one customer short sale in 2010) and imposed a US $1 million fine against ETC and the two principals, as well as other sanctions.
The firm and the two principals appealed the BCC’s decision to CBOE’s Board of Directors; the Board upheld the BCC’s decision. The applicants then appealed to the SEC.
In ruling against CBOE, the SEC said the CIP rule only required ETC “to verify the identity of the named account holder.” Because ETC’s named customers were the two omnibus brokers, it was only required to apply its CIP requirements to them. For this reason too, only the omnibus brokers, not their traders, were subject to CBOE’s margin rules.
Finally, the SEC noted that ETC temporarily deactivated its surveillance system for bona fide reasons – to make the monitoring tool web-based, as it was requiring “extensive computer resources to run,” and not operating efficiently. During the time it deactivated its automated monitoring system, ETC employed other measures to help prevent wash and manipulative trading. Moreover, once it reactivated its automated surveillance system, ETC reviewed all trades that occurred while the system was down, said the SEC. As a result, concluded the SEC, ETC’s wash sale surveillance was not “unreasonable” during the relevant time period.
The SEC remanded the entire action against the firm and the two principals back to CBOE for reconsideration as CBOE’s fine and sanctions were based on findings related to all its initial charges, including the ones the SEC set aside in its decision.
Compliance Weeds: The Financial Crimes Enforcement Network recently finalized rules requiring banks, broker-dealers, future commission merchants, introducing brokers and mutual funds (collectively, “covered firms”) to identify the beneficial owners of their legal entity customers. Such entities are currently required to know the identity of each of their legal entity customers under their CIP requirements, but not necessarily their beneficial owners. FinCEN also adopted rules making explicit the obligation of covered firms to understand the nature and purpose of their customer relationships in order to develop customer risk profiles; conduct ongoing monitoring for reporting suspicious transactions; and, on a risk basis, maintain and update customer information. Covered firms must comply with FinCEN’s new rules beginning May 11, 2018. (Click here for details of these new rules in the article, “FinCEN Finalizes Rules Requiring Banks, Broker-Dealers, FCMs, Mutual Funds and IBs to Help Verify Beneficial Owners of Certain Accounts” in the May 8, 2016 edition ofBridging the Week.)