Under-Resourced Compliance Blamed for Customer Protection Shortfalls

A large clearing broker-dealer agreed to pay over $1.3 Million in disgorgement, interest, and fines to settle charges that it underfunded its reserve account.  Due to a coding error, the firm miscalculated its reserve formula pursuant to the customer protection rule (15c3-3) resulting from repos with its parent company.  After discovery by a FINRA examination team, the broker-dealer deposited $133 Million into its reserve account, thereby triggering a liquidity crisis for the firm as it worked to raise the necessary capital.  The SEC criticized the BD, which has had other compliance issues, for a “lack of personnel for a regulated entity of its size and import.”

OUR TAKE: Under-resourcing compliance is a red flag for regulators and often leads to enforcement actions.  Firms should spend no less than 5% of revenue on compliance infrastructure and should spend more where their activities involve several complex processes.