Bright Smart Securities fine points to clear SFC expectations on pre-trade controls and surveillance
A few days ago, the SFC fined Bright Smart Securities $2.8m for internal control failures in monitoring suspicious trades. The fine is a stark reminder of the SFC’s expectation that brokers and trading platforms maintain controls to detect and prevent market misconduct. This is underpinned by the code of conduct for licensees, which requires that firms:
“have internal control procedures and financial and operational capabilities which can be reasonably expected to protect its operations, its clients and other licensed or registered persons from financial loss arising from theft, fraud, and other dishonest acts, professional misconduct or omissions” paragraph 4.3 (Internal control, financial and operational resources).”
However, there has been a wide variance in practices among broking firms, as they seek to design a control environment which will satisfy this requirement, in a manner which is reasonable and proportionate to their business. In the case of Bright Smart Securities, this included primarily manual, post-trade controls, despite handling a significant volume of client trades.
Following this disciplinary action it is now clear that, for firms with significant client volumes, the SFC expects:
Firms should maintain automated, pre-trade controls which would prevent transactions which fit known market misconduct typologies. In the case of Bright Smart Securities, the misconduct in question was identified as wash trading, but many other types of market misconduct could potentially be flagged or prevented with pre-trade controls.
Surveillance should not be the only control against market misconduct, as it is inherently reactive in nature. Where surveillance is used as a control, it should be properly calibrated, supported by robust case management, and result in effective restrictions to client trading where potential misconduct is identified.
It is also noteworthy that the wash trades in this case were originally identified and escalated to the SFC by the HKEx. Firms should therefore be aware that if their systems fail to detect suspicious behaviour, and this behaviour is subsequently identified by another party to the transaction, this could result in similar questions being raised about the adequacy of their controls.
In our view, best practice in the detection and prevention of market misconduct is grounded in a comprehensive market misconduct risk assessment. First firms should identify the market misconduct typologies to which they have the greatest exposure, given the nature of their broking activity, product coverage and clientele. This in turn allows firms to identify proportionate controls, tailored to the specific risks they face.
We work with firms to improve their market misconduct controls. We can help you to:
Build a comprehensive market misconduct risk assessment;
Identify appropriate controls for the risks you face (policies and procedures, staff training, pre-trade controls and surveillance);
Select and calibrate surveillance systems; and
Provide independent advice on individual cases of potential market misconduct.
Get in touch if you’d like to discuss how we could help.
