Peter von Maur is a director and senior counsel in the Law Group of RBC Capital Markets Corporation, based in New York. He provides legal support to the firm's capital market businesses on a broad range of industry-related matters, including regulatory investigations and enforcement proceedings, compliance practices and procedures, emerging regulatory issues, cross-border issues, securities lending, and prime brokerage and operations-related matters. He periodically speaks on these topics at industry conferences and is a contributor to a number of industry publications. Peter has practiced in the securities industry for over 20 years. He has previously worked as internal counsel for Prudential Securities Inc and Citibank. Peter is a graduate of Franklin and Marshall College, and of New York Law School.
ABSTRACT
This paper discusses alternative strategies for the effective management of supervisory policies and procedures of broker-dealers operating in the USA. It provides legal analysis and practical advice concerning the creation and management of procedures in a broker-dealer, and offers some useful alternatives for achieving that goal. The approach of the paper is to view a firm's procedures as a living, breathing organism that must continuously evolve and adapt to changes in its environment. These changes may arise from external sources, such as new rulemaking or regulatory guidance, or from internal sources, such as new businesses and/or products. In order for a broker-dealer to have a successful and effective system of supervision, its procedures must be continuously evaluated (and, where appropriate, modified) in light of changes in its environment.
KEYWORDS: supervision, supervisory structure, policy, procedures, regulators, regulatory requirements, maintenance, broker-dealer, New York Stock Exchange (NYSE), National Association of Securities Dealers (NASD), European Community (EC), management, rulemaking, foundation, testing, verification, gap analysis, culture of compliance, commitment
INTRODUCTION
This paper discusses alternative strategies for the effective management of supervisory policies and procedures (together, 'procedures') of broker-dealers ('firm' or 'firms') operating in the USA. It focuses less on a legal analysis than it does on practical advice about the creation and management of procedures in a broker-dealer, and offers some useful alternatives towards that goal. Generally speaking, a firm's procedures should be viewed as a living, breathing organism that must continuously evolve and adapt to changes in its environment. These changes may arise from external sources, such as new rulemaking or regulatory guidance, or from internal sources, such as new businesses and/or products.
Procedures in a broker-dealer do, indeed, appear to some as a living, breathing thing. As in the environment in which all living things exist, the social and commercial system in which broker-dealers operate is one in which human actions and inactions influence others in a harmful or beneficial way. A broker-dealer's procedures are impacted by, and must respond to, external actors, such as litigants and regulators, and internal actors, such as new products and business lines. If they fail to respond, they will fail to achieve the objective for which they were created (ie the foundation for effective supervision within a firm). The impact of such failure can lead to significant regulatory, reputational and/or financial risk. By treating procedures as a dynamic living, breathing organism, rather than as a static set of guidelines that are updated from time to time, firms will reduce the risk that their procedures will be inadequate for the supervision of their businesses and the risk of legal, reputational and/or financial consequences.
A BRIEF REVIEW OF UNDERLYING LEGAL AND REGULATORY REQUIREMENTS: 'WHAT'S THE BIG DEAL?'
Broker-dealers are required to maintain a system of supervision, including written procedures, that is reasonably designed to achieve compliance with US federal securities laws, and the various rules and regulations applicable to their business activities.
Section 15(b)(4)(E) of the US Securities Exchange Act of 1934 provides that the Securities Exchange Commission (SEC) may impose sanctions on any firm, or person associated with a firm, who: has failed reasonably to supervise, with a view to preventing violations of the provisions of the securities laws or the rules thereunder by another person who commits such a violation, if such other person is subject to his supervision...1
The section, however, provides for an affirmative defence to a charge of failure to supervise if:
1. a broker-dealer has in place proper supervisory procedures;
2. the supervisory personnel followed those procedures;
3. the supervisory personnel had no reason to suspect any violation by an employee.2
Both the New York Stock Exchange (NYSE) and the US National Association of Securities Dealers Inc (NASD) require member organisations to have processes in place to establish, maintain, modify and test policies and procedures that are reasonably designed to achieve compliance not only with their own rules, but with other applicable securities laws and regulations as well.3 (All regulatory bodies, including those mentioned above, are collectively referred to as 'regulators'.)
Indeed, NYSE and NASD rules require broker-dealers to prepare a report by 1st April of each year that addresses (among other things) a firm's supervision and compliance efforts during the preceding year. The rules require each firm's report to include a certification, signed by the firm's chief executive officer (CEO), that the firm has in place processes and procedures that are designed to achieve compliance with the various regulatory rules. The certification itself contains a representation by the firm's CEO that the firm has processes in place to establish, maintain, review, test and modify its supervisory procedures that are reasonably designed to achieve compliance with applicable securities laws and regulations.4
It is clear, then, that regulators not only expect firms to have complete procedures, but also to have processes in place to test and modify them as needed to account for the ongoing changes in the firm's environment (eg new or amended rules and/or regulations, and/or changes in the firm's business model). One need only consider the number of examination findings and/or enforcement actions that contain allegations of a failure to supervise, based on absence of, or inadequate, supervisory procedures, to see how critical it is that a firm has a complete, up-to-date set of procedures. In fact, a very rough analysis of the disciplinary decisions published by the NYSE in the first two weeks of July 2007 reveal that eight out of 19 matters contain findings of a failure to supervise.5 The following are samples of the typical failure to supervise language that is contained in a disciplinary decision: Violated NYSE Rule 342 by failing to establish and maintain appropriate systems and procedures for supervision and control of areas responsible for 6 failing to establish adequate policies and procedures, including system of follow-up and review, for compliance with 7
Importantly, the findings of failure to supervise are against both firms and individuals. Indeed, one of the matters involved the failure of a firm's compliance officer to establish adequate supervisory procedures.8 It is clear that it is easy for regulators to add a failure to supervise violation as part of any alleged rule violation, especially if a firm does not have adequate procedures in place that address the alleged violation. This can potentially impact the amount of fine or other punishment that is levied as part of the underlying violation.
The NYSE issued an Information Memorandum in 2005 that discussed the factors considered by the NYSE Division of Enforcement in determining sanctions.9 According to the Memorandum, one of the primary factors considered by the NYSE is the 'effectiveness' of a firm's 'supervisory and compliance policies and procedures'.
In a recent speech, Mary Ann Gadziala, associate director of the SEC Office of Compliance Inspections and Examinations, made it clear that the SEC was 'looking to firms to take a more proactive approach, anticipating problems and implementing controls to prevent violations'. She stated that:
Supervision continues to be a top examination priority for the SEC examination program. We are looking for written supervisory procedures that are complete, updated to keep pace with regulatory or business changes, and perhaps most importantly, followed.10
On a more practical level, procedures are often the first thing that a regulator will request in connection with an examination or investigation. As such, it is a firm's opportunity to make a good 'first impression' with a regulator. Conversely, inadequate procedures can create a negative 'first impression', which can have a detrimental impact on the outcome of an examination or investigation.
SMALL FIRM/BIG FIRM: 'SIZE MATTERS'
Broker-dealers come in all sizes, shapes and forms, as do living organisms. Some are composed of a handful of people and focus on a limited number of products; some are huge, full-service, multinational firms with thousands of employees and a wide array of business lines. Likewise, the methods used by broker-dealers to manage their procedures come in all sizes, shapes and forms. Not surprisingly, the structure of a firm's system of supervision, including its supervisory policies and procedures, is directly related to its size and complexity. The management of procedures can be relatively straightforward for a smaller organisation and more complex for larger, geographically diverse organisations; similarly, the resources that a firm can commit to the establishment, maintenance, modification and testing of its procedures - eg personnel, technology and/or financial resources - varies greatly. Clearly, managing policies and procedures in a broker-dealer is not a 'one size fits all' proposition. Most importantly, however, firms must take steps to ensure that their procedures respond appropriately to stimuli within their environment, ie to changes in rules and regulations, enforcement actions, litigations and/or changes in the business model of a firm (eg expansion of business lines).
Regardless of the size or complexity of a broker-dealer, effective management of procedures is critical and requires commitment. There are ongoing developments from numerous sources both inside and outside of a broker-dealer, and the impact of these on a firm's procedures must be considered. Effective management of a firm's procedures is a creative and interactive process that depends not only on the size, complexity and resources of a firm, but also on other intangibles, such as personalities, culture and attitude. What follows are only some of the different techniques that a firm can apply to help to manage this process (ie to create, maintain, update and test its procedures).
PART I: LAYING THE FOUNDATION - CREATING A COMPLETE SET OF PROCEDURES
Because a firm's procedures not only form the basis of how a firm supervises its business, but also serve as the foundation upon which future amendments, additions and revisions will be based, it is critical that a firm starts with a comprehensive, up-to-date set of procedures that provide for the appropriate supervision of its business. As discussed below, these procedures will need to be revised, amended and supplemented on an ongoing basis in response to changes that originate from both inside and outside the firm. If procedures are to be viewed as a living organism, an incomplete set of procedures will severely limit a firm's ability to adapt successfully to changes in its environment.
There are numerous alternatives available to firms to ensure that a complete set of procedures is in place. The method selected by a firm will often depend on the status of its current procedures. Firms with substantially complete procedures will want to retain and supplement, or revise, them to create a complete set. Firms with less complete procedures may decide to replace their procedures with an entirely new set of complete procedures.
Gap analysis
Firms with substantially complete procedures in place may consider conducting a 'gap analysis' to ensure that their procedures cover all required areas of supervision. Gap analysis involves matching the firm's existing procedures against applicable regulatory requirements. If no procedure exists to address a regulatory requirement, a gap will be found: new procedures will need to be created, or existing procedures revised, to close that gap. Gap analysis is one of the more common ways in which firms have assessed the completeness of their procedures.
Some firms have used the NASD's new member Written Supervisory Procedures Review Checklist ('WSP Checklist') to facilitate this exercise.11 On completing the analysis, the firm should have a complete set of procedures upon which to base future updates.
Replacement of existing procedures with new procedures
Firms that do not have an existing set of procedures to serve as a foundation, or those whose procedures may not be adequate or may not lend themselves to a gap analysis, may consider replacing their existing procedures with an entirely new set of supervisory procedures. The new procedures can be created using internal resources or obtained through an outside source (ie a law firm or other external vendor). Creating the procedures using internal resources will require substantial time and effort on behalf of firm personnel, which may be problematic for small firms. Using procedures obtained from an outside source will require less time and effort of internal personnel, but will entail a financial outlay.
Procedures that are available from outside sources can offer additional advantages. Many vendors have templates of procedures for almost every line of business in which broker-dealers may be engaged. Some of these products enable firms to customise the templates to their business through a 'Wizard'-type function. The procedures are specifically designed to cover NASD, NYSE, federal and other applicable laws and regulations. As such, they can help a firm to ensure that all applicable laws and regulations are addressed by its procedures. Moreover, some vendors have ongoing services that periodically provide suggested revisions and/or additions to their procedures, in response to new and amended regulatory requirements. These services can provide valuable assistance to firms in updating and keeping procedures current.
Care should be taken, however, when using an 'off-the-shelf' product or template that has been obtained from an outside source. These templates must be customised to the firm and its business lines. Regulators have made it clear that merely using an off-the-shelf version of procedures, without an appropriate degree of customisation to the firm, is unacceptable. Also, an off-the-shelf version of procedures may not match up to what is actually occurring within the firm. Having existing procedures that are not being followed invites a 'failure to supervise' finding by a regulator. In some cases, it is worse than having no procedures at all. At the very least, drafts of the procedures should be provided to appropriate legal, compliance and business personnel for their review, comment and revision, prior to the procedures' internal distribution and implementation. This process will facilitate a common understanding of the procedures within the firm and help build a commitment that they will be followed.
PART II: ESTABLISHING THE PROCEDURES - 'KEEPING THE MESSAGE ALIVE'
The challenge does not end with the creation of a complete set of procedures. It is critical for firm personnel to be, and to remain, familiar with its procedures. Accordingly, efforts must be made to familiarise employees with, and to stress the importance of, the procedures on an ongoing basis. As noted above, regulators will almost always demand copies of a firm's procedures during the course of an examination or investigation. They will compare those procedures to the information that they gather during the course of their examination, which will generally include interviews with a variety of firm personnel. It is not only embarrassing, but also potentially harmful to the outcome of an examination, for an employee not to be familiar with, or to misunderstand, a firm's procedures.
Procedures should be readily available to firm personnel for review and consultation. Traditionally, hard-copy procedures manuals have been provided to employees. Updates to the procedures have been distributed in hard-copy updates or as complete new procedures manuals. This has been an acceptable, if rather cumbersome, alternative for small firms who do not have access to more sophisticated means of distributing updates. It also encourages firm personnel to review the updates as they are received and incorporated into the firm's procedures manuals. A downside, however, is that it relies on employees to update their manuals. Failure of firm personnel to update their manuals will lead to different out-of-date versions of procedures being used within the firm. Printing and distributing hard-copy versions of the manual or procedures may also be costly and time-consuming. As a consequence, procedures may be updated less frequently than they should be.
If possible, procedures should be available electronically on the firm's intranet or website. Hosting a firm's procedures electronically on the firm's intranet or other website allows the firm to control the version of the procedures that is being used. This eliminates the danger of the retention of out-of-date versions. Firm personnel can be notified of updates through e-mails, easing the problems (eg of cost and frequency) that are associated with the distribution of hard-copy updates. This is particularly helpful for large firms that are geographically dispersed. Matters of importance or reminders regarding the procedures can be easily communicated. Where appropriate, personnel can be required to acknowledge that they have received and reviewed updates. Employee acknowledgements can be tracked. Importantly, use of these electronic tools creates an audit trail that enables a firm to document its procedures, each update to the procedures and their distribution to relevant personnel. This electronic alternative, however, will require financial, technological and employee resources that small firms may not have immediately at their disposal.
Firms should strongly consider providing training to employees in connection with their procedures, because this represents a unique opportunity to communicate requirements clearly. Training can be given in connection with specific procedures, updates and/or businesses as a firm sees fit. Firms will need to decide on what topics, and for whom, such training should be provided. Depending on the size and resources of a firm, there are a number of alternative methods through which to deliver training. While live training is effective and particularly attractive for smaller firms, it may pose issues for larger, geographically diverse firms. Conference calls, video conferences and/or webcasts can alleviate the restrictions that are inherent to live training. Firms with more resources may consider other electronic alternatives, such as web-based training modules. These can include a testing element, if appropriate.
The annual compliance meeting, or firm element training, is an opportunity that is often used by firms to remind employees of the importance of its procedures. Annual meetings between the
CEO and senior management are held in some firms, at which the importance of, and the ongoing responsibilities of senior management in relation to, procedures are discussed. Senior managers are then responsible for communicating this message to their business units. Firms can take the opportunity to incorporate communications relating to their procedures into the yearly employee-related reporting processes (eg those relating to outside business affiliations and personal accounts). Some firms require employees to make a 'sub-certification' in connection with the CEO certification process described above, which may include an acknowledgment that employees have read and understood its procedures.
The alternatives discussed above, along with many others, are available to firms to help them to establish their procedures and 'keep the message alive'. Firms should be creative in choosing which alternative works best for them given, among other things, their size, resources, complexity, business lines and geographical dispersion.
Evidence of compliance with supervisory procedures
The use of checklists or other evidence of supervisory review can help firms to keep personnel focused on their responsibilities. The administration of such programmes, however, can be time-consuming. Depending on the resources available, a firm might consider relying on electronic functionality to create, submit and track checklists, or other evidence of supervision, under its procedures. Such functionality might facilitate this process. Keep in mind, however, that the use of checklists can be extremely harmful to a firm if they are not properly completed. Regulators may view such a failure as evidence that a business is not being properly supervised.
PART III: ONGOING MAINTENANCE OF THE PROCEDURES - 'KEEPING UP WITH THE JONESES'
The creation of new procedures is just the beginning of the process. Maintaining current and effective procedures in a broker-dealer requires creative and effective management. Once a firm has established its procedures, the challenge becomes how to stay abreast of the overwhelming number of developments, from both inside and outside a firm, which may impact them. Keep in mind that a firm's procedures are a living, breathing thing that must adapt and evolve in response to changes in the firm's internal and external environment. Every day, the securities industry is full of data, news, developments, announcements, pronouncements and guidance, all of which potentially impact a firm's procedures. Likewise, changes within a firm must be carefully monitored (eg the opening of a new business line). Considering the pace at which change occurs, keeping up with all of these events poses an extremely difficult and time-consuming task. Nevertheless, these internal and external developments (stimuli) must be tracked and their potential impact on a firm's procedures evaluated on an ongoing basis. Failure to do so may lead to businesses that are not properly supervised. The following are some of the sources of events that may impact a firm's procedures and suggestions for managing them.
Regulatory developments: rulemaking; enforcement actions
The most obvious source of events that can potentially impact a firm's procedures are regulatory developments. Regulatory developments include, but are not limited to:
1. rulemaking by federal, state, regulatory and self-regulatory organizations (SROs), and other securities-related bodies;
2. enforcement actions by regulators;
3. other guidance issued by regulators (eg no-action letters, information memoranda, and interpretative releases).
Because regulatory developments will be the primary source of input that may lead to the revision of procedures and because of the fact that they occur at an alarming pace, these developments must be constantly monitored. Firms should consider how to resource this important function.
Whether the responsibility is vested in one individual, or several individuals across business and functional lines, it is essential that regulatory developments are watched and catalogued, and that their potential impact on a firm's procedures is carefully evaluated.
There are numerous sources that are available to firms to help them to monitor regulatory developments. There is a wealth of information available from the SEC, NYSE and NASD websites. Law firms typically publish regulatory updates that are also available on the Internet. Likewise, vendors provide services that are designed to capture all significant regulatory developments. Some of the same vendors discussed above, which assist firms in creating procedures, also provide suggested updates to the procedures on a periodic basis
(eg monthly, bimonthly). These updates reflect regulatory developments that impact a broker-dealer's supervision of business.
Firms must consider which of these alternatives will best leverage their resources. In making the determination, a firm should consider its structure, business lines and resources.
Regulatory examinations and inquiries
Broker-dealers are subject to ongoing inquiries, examinations and audits (ie regulatory reviews) from regulators, SROs and other membership organisations. The impact on a firm's procedures of the findings of these regulatory reviews, or of the issues raised during the course of these reviews, should be carefully considered. This is especially the case because regulators will typically follow up on what corrective measures, if any, have been taken by a firm in connection with such findings or issues raised. The failure of a firm to take appropriate action invites regulators to consider more severe findings or punishment. Indeed, the NYSE will take such matters into consideration when determining its recommended penalties. A good example of this can be found in a recent NYSE disciplinary decision involving Bishop Rosen & Co. Inc. The enforcement action originated from the findings of two prior examinations of the firm in 2002 and 2003. In reaching its decision, the hearing panel specifically took into account efforts that the firm had made in response to prior examination findings.12
Internal investigations/internal audit examinations
Similarly to the regulatory examinations/investigations discussed above, the effect of the results of internal audit examinations or other internal investigations on a firm's procedures should be evaluated. TheNYSE, in its Information Memorandum referenced above, stated that it would consider a firm's 'corrective measures', including improvement of procedures in response to the discovery of problems, in determining sanctions against a firm.13 Also, Mary Ann Gadziala, in the speech referenced above, stated that the SEC may consider limiting the scope of its examination of firms by 'leveraging off quality, effective internal audit work performed by firms'. She went on to say that:
[the SEC's] on the firm's own independent reviews will depend on whether examiners can be confident that effective independent oversight has been conducted and that the firm has taken meaningful corrective action.14
Litigation and other matters
Issues may arise in the course of litigations or other firm matters that may affect a firm's procedures. The impact of these issues must be considered.
New businesses or products
New procedures, or the revision of existing procedures, may be required to provide for the appropriate supervision of new businesses or products introduced at a firm. Accordingly, the launch of new businesses or products must be monitored. The NASD has provided guidance to member firms on best practices to be used in connection with the introduction of new products.15 Firms should consider development of regularised processes, such as the use of a 'new business committee', for the review and approval all new activity and/or products in a broker-dealer. Firms should consider whether the existence of appropriate supervisory procedures should be a condition of approval in such a process. At the very least, firms should take steps to ensure that new businesses and products are properly supervised, and that appropriate procedures are in place.
Ongoing testing of procedures
As referenced above, firms are required to conduct ongoing testing of the effectiveness of their procedures. The outcome of such testing will directly impact a firm's procedures. Firms are also required to have procedures that govern such testing. These testing procedures should include a means for the identification of areas that will be reviewed, and the prioritization and frequency of testing in those areas. Factors that may be considered in making this determination include:
previously identified issues;
size of business;
revenues; and
input from personnel (ie compliance, legal).
The testing procedures should provide the overall format or testing plan for the reviews. Generally speaking, testing should attempt to assess the effectiveness of the firm's procedures by comparing the procedures against business or functional unit practices and relevant rules. A schedule for conducting the reviews, assignment of responsibility for the reviews and reporting results of the reviews should also be included in the testing procedures. Any new businesses or products (as discussed above) should be added to the schedule for testing.
The results of the testing are required to be reported to the firm's CEO on an annual basis. Regulators may ask to review the results of the testing, as well as the firm's corrective action, if any has been taken in response to the results. Accordingly, it is critical that firms carefully consider the impact of the results of the testing on its procedures and take appropriate action.
PART IV: MANAGING THE FLOW OF INFORMATION
Perhaps the greatest challenge to maintaining effective procedures is the monitoring and evaluation of the many different sources of information that impact, or could potentially impact, a firm's procedures. As noted, the method by which a firm chooses to accomplish this objective is dependent on the size, resources and complexity of that firm. Whatever the method, however, it is essential that these sources are monitored on a continuous basis for matters that may warrant revision of the procedures. Understandably, such a responsibility may be overwhelming for only one person. Some firms have dedicated staff to handle this process; others have formed a committee to manage it. Members of such a committee typically include personnel from the principal business and functional groups within the firm. Committee members are responsible for monitoring and synthesising, on an ongoing basis, developments from various sources that may merit modification of the firm's procedures, and must report their conclusions to the committee for consideration. The committee meets periodically to consider any, and all, matters that may cause the firm to update its procedures. In effect, the committee acts as a 'safety net', designed to catch all developments that may impact the firm's procedures. Committee members are generally responsible for reviewing and approving proposed revisions to the procedures. At a larger firm, members might include representatives from the following groups:
legal;
compliance;
finance;
operations;
equity sales and trading;
fixed income sales and trading;
investment banking;
research;
tax;
structured products;
internal audit; and
technology
Responsibilities are assigned to each of the committee members. For example, the representatives from legal and compliance may report on significant regulatory developments, regulatory exam findings and litigation issues; the business groups would address any planned new business and/or products. All of the members should report on any issue or matter that comes to their attention that may impact the firm's procedures. In order to manage this process properly, a clear agenda should be set. The committee as a whole should discuss the impact of all developments. Specific business or functional units impacted by a development should play a major role in the creation or revision of procedures in response to the development (eg in relation to
Regulation NMS: equity sales and trading; operations; technology; legal; compliance). Responsibilities should be clear and assigned.
PART V: COMMUNICATION OF CHANGES AND VERSION MANAGEMENT - 'THE FINAL FRONTIER'
Once a firm's procedures have been revised, a process should be in place to distribute the revisions to affected firm personnel. As discussed in greater detail in Part II, this process can be managed in a number of different ways. Depending on resources, hard copies may be distributed. At other firms, revisions may be distributed electronically as bulletins and posted on the firm's intranet. In either case, arrangements must also be made to archive retired procedures.
Electronic application
Some firms use an electronic application to manage the publication, distribution and archiving process. The application assists firms in creating, publishing and maintaining existing procedures, and in creating and distributing revised procedures. The application also houses archived versions of the procedures. It allows authorised users to distribute the revised procedures to firm personnel and to track receipt. When revised procedures are created, the procedures being replaced are electronically dated and archived within the application for future reference.
Documentation of processes
However a firm chooses to manage its procedures, the process should be appropriately documented. Should an issue arise, regulators will want to see evidence of a thoughtful and reasoned approach to the establishment, maintenance, review, testing and modification of the firm's procedures.
A FINAL NOTE: COMMITMENT - 'IT DON'T MEAN A THING, IF IT AIN'T GOT THAT SWING'
In light of the tremendous effort required, the effective management of a firm's procedures will not be possible without the ongoing commitment of the firm and its personnel. Without such commitment, this objective will be lost in the day-to-day struggle to compete in the broker-dealer world. The approach taken by a firm to maintaining this commitment will vary with its personality. At the very least, there should be buy-in at the level of senior management.
Employees should be reminded of the senior management's commitment periodically. Appropriate resources should be made available with which to manage the process effectively. Personnel might be rewarded, or recognised, for their efforts. Although it is an overused phrase, regulators are not mistaken in regularly urging firms to adopt a 'culture of compliance'.16 But this should not be misconstrued as a suggestion that business be inappropriately restrained within a firm; rather, it should be interpreted as succinct and valuable guidance that a firm-wide commitment is critical to the effective management of procedures.
CONCLUSION
Procedures appear to be, then, a living, breathing thing. They demand constant attention and nurturing. They must evolve and adapt to the ever-changing environment around them. Above all, they require commitment: if they are not nurtured, if they do not evolve and adapt, they will fail to serve the purpose for which they were created - the effective supervision of the firm.
The methodology used by a firm to tackle the challenge of effectively managing its procedures will vary with the personality of the organisation. This is a task that demands creative and innovative solutions, tailored to the size, complexity, resources, personality and culture of a firm.
REFERENCES
(1) 15 USC s78o.
(2) Ibid.
(3) See NYSE Rule 342 and NASD Rules 3010, 3012 and 3013.
(4) Ibid.
(5) See Thomas M Ruddy, NYSE Hearing Board Decision 07-089, 11th July, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#07-089).
(6) Schon-Ex LLC, NYSE Hearing Board Decision 06167, 12th December, 2006.
(7) Piper Jaffray & Co., NYSE Hearing Board Decision 07082, 31st May, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#07-082).
(8) James P Dalton, NYSE Hearing Board Decision 07-075, 22nd May, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#07-075).
(9) NYSE Information Memorandum 0577 Factors Considered By The New York Stock Exchange Division Of Enforcement In Determining Sanctions, 7th October, 2005.
(10) Mary Ann Gadziala, associate director, US Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations (2007) The Regulatory Focus on Broker-Dealer Legal and Compliance Issues, Speech to the Securities Industry and Financial Markets Association (SIFMA) Legal and Compliance Division, 7th June, available online at http://www.sec.gov/news/speech/2007/spch060707mag.htm.
(11) Available online at http://www.nasd.com/web/groups/corp_comm/documents/home_page/nasdw_009839.pdf.
(12) Bishop Rosen & Co. Inc., NYSE Hearing Board Decision 0695, 1st February, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#06-095).
(13) NYSE Information Memorandum 0577, supra.
(14) Gadziala, supra.
(15) NASD Notice To Members 0526 NASD Recommends Best Practices For Reviewing New Products, April 2005, available online at http://www.finra.org/RulesRegulation/NoticestoMembers/2005NoticestoMembers/p013756.
(16) David Glauber, NASD chairman and CEO (2004) Update From NASD, Speech at the Securities Industry Association (SIA) Annual Conference, Boca Raton, FL, 4th November.
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Peter von Maur is a director and senior counsel in the Law Group of RBC Capital Markets Corporation, based in New York. He provides legal support to the firm's capital market businesses on a broad range of industry-related matters, including regulatory investigations and enforcement proceedings, compliance practices and procedures, emerging regulatory issues, cross-border issues, securities lending, and prime brokerage and operations-related matters. He periodically speaks on these topics at industry conferences and is a contributor to a number of industry publications. Peter has practiced in the securities industry for over 20 years. He has previously worked as internal counsel for Prudential Securities Inc and Citibank. Peter is a graduate of Franklin and Marshall College, and of New York Law School.
ABSTRACT
This paper discusses alternative strategies for the effective management of supervisory policies and procedures of broker-dealers operating in the USA. It provides legal analysis and practical advice concerning the creation and management of procedures in a broker-dealer, and offers some useful alternatives for achieving that goal. The approach of the paper is to view a firm's procedures as a living, breathing organism that must continuously evolve and adapt to changes in its environment. These changes may arise from external sources, such as new rulemaking or regulatory guidance, or from internal sources, such as new businesses and/or products. In order for a broker-dealer to have a successful and effective system of supervision, its procedures must be continuously evaluated (and, where appropriate, modified) in light of changes in its environment.
KEYWORDS: supervision, supervisory structure, policy, procedures, regulators, regulatory requirements, maintenance, broker-dealer, New York Stock Exchange (NYSE), National Association of Securities Dealers (NASD), European Community (EC), management, rulemaking, foundation, testing, verification, gap analysis, culture of compliance, commitment
INTRODUCTION
This paper discusses alternative strategies for the effective management of supervisory policies and procedures (together, 'procedures') of broker-dealers ('firm' or 'firms') operating in the USA. It focuses less on a legal analysis than it does on practical advice about the creation and management of procedures in a broker-dealer, and offers some useful alternatives towards that goal. Generally speaking, a firm's procedures should be viewed as a living, breathing organism that must continuously evolve and adapt to changes in its environment. These changes may arise from external sources, such as new rulemaking or regulatory guidance, or from internal sources, such as new businesses and/or products.
Procedures in a broker-dealer do, indeed, appear to some as a living, breathing thing. As in the environment in which all living things exist, the social and commercial system in which broker-dealers operate is one in which human actions and inactions influence others in a harmful or beneficial way. A broker-dealer's procedures are impacted by, and must respond to, external actors, such as litigants and regulators, and internal actors, such as new products and business lines. If they fail to respond, they will fail to achieve the objective for which they were created (ie the foundation for effective supervision within a firm). The impact of such failure can lead to significant regulatory, reputational and/or financial risk. By treating procedures as a dynamic living, breathing organism, rather than as a static set of guidelines that are updated from time to time, firms will reduce the risk that their procedures will be inadequate for the supervision of their businesses and the risk of legal, reputational and/or financial consequences.
A BRIEF REVIEW OF UNDERLYING LEGAL AND REGULATORY REQUIREMENTS: 'WHAT'S THE BIG DEAL?'
Broker-dealers are required to maintain a system of supervision, including written procedures, that is reasonably designed to achieve compliance with US federal securities laws, and the various rules and regulations applicable to their business activities.
Section 15(b)(4)(E) of the US Securities Exchange Act of 1934 provides that the Securities Exchange Commission (SEC) may impose sanctions on any firm, or person associated with a firm, who: has failed reasonably to supervise, with a view to preventing violations of the provisions of the securities laws or the rules thereunder by another person who commits such a violation, if such other person is subject to his supervision...1
The section, however, provides for an affirmative defence to a charge of failure to supervise if:
1. a broker-dealer has in place proper supervisory procedures;
2. the supervisory personnel followed those procedures;
3. the supervisory personnel had no reason to suspect any violation by an employee.2
Both the New York Stock Exchange (NYSE) and the US National Association of Securities Dealers Inc (NASD) require member organisations to have processes in place to establish, maintain, modify and test policies and procedures that are reasonably designed to achieve compliance not only with their own rules, but with other applicable securities laws and regulations as well.3 (All regulatory bodies, including those mentioned above, are collectively referred to as 'regulators'.)
Indeed, NYSE and NASD rules require broker-dealers to prepare a report by 1st April of each year that addresses (among other things) a firm's supervision and compliance efforts during the preceding year. The rules require each firm's report to include a certification, signed by the firm's chief executive officer (CEO), that the firm has in place processes and procedures that are designed to achieve compliance with the various regulatory rules. The certification itself contains a representation by the firm's CEO that the firm has processes in place to establish, maintain, review, test and modify its supervisory procedures that are reasonably designed to achieve compliance with applicable securities laws and regulations.4
It is clear, then, that regulators not only expect firms to have complete procedures, but also to have processes in place to test and modify them as needed to account for the ongoing changes in the firm's environment (eg new or amended rules and/or regulations, and/or changes in the firm's business model). One need only consider the number of examination findings and/or enforcement actions that contain allegations of a failure to supervise, based on absence of, or inadequate, supervisory procedures, to see how critical it is that a firm has a complete, up-to-date set of procedures. In fact, a very rough analysis of the disciplinary decisions published by the NYSE in the first two weeks of July 2007 reveal that eight out of 19 matters contain findings of a failure to supervise.5 The following are samples of the typical failure to supervise language that is contained in a disciplinary decision: Violated NYSE Rule 342 by failing to establish and maintain appropriate systems and procedures for supervision and control of areas responsible for 6 failing to establish adequate policies and procedures, including system of follow-up and review, for compliance with 7
Importantly, the findings of failure to supervise are against both firms and individuals. Indeed, one of the matters involved the failure of a firm's compliance officer to establish adequate supervisory procedures.8 It is clear that it is easy for regulators to add a failure to supervise violation as part of any alleged rule violation, especially if a firm does not have adequate procedures in place that address the alleged violation. This can potentially impact the amount of fine or other punishment that is levied as part of the underlying violation.
The NYSE issued an Information Memorandum in 2005 that discussed the factors considered by the NYSE Division of Enforcement in determining sanctions.9 According to the Memorandum, one of the primary factors considered by the NYSE is the 'effectiveness' of a firm's 'supervisory and compliance policies and procedures'.
In a recent speech, Mary Ann Gadziala, associate director of the SEC Office of Compliance Inspections and Examinations, made it clear that the SEC was 'looking to firms to take a more proactive approach, anticipating problems and implementing controls to prevent violations'. She stated that:
Supervision continues to be a top examination priority for the SEC examination program. We are looking for written supervisory procedures that are complete, updated to keep pace with regulatory or business changes, and perhaps most importantly, followed.10
On a more practical level, procedures are often the first thing that a regulator will request in connection with an examination or investigation. As such, it is a firm's opportunity to make a good 'first impression' with a regulator. Conversely, inadequate procedures can create a negative 'first impression', which can have a detrimental impact on the outcome of an examination or investigation.
SMALL FIRM/BIG FIRM: 'SIZE MATTERS'
Broker-dealers come in all sizes, shapes and forms, as do living organisms. Some are composed of a handful of people and focus on a limited number of products; some are huge, full-service, multinational firms with thousands of employees and a wide array of business lines. Likewise, the methods used by broker-dealers to manage their procedures come in all sizes, shapes and forms. Not surprisingly, the structure of a firm's system of supervision, including its supervisory policies and procedures, is directly related to its size and complexity. The management of procedures can be relatively straightforward for a smaller organisation and more complex for larger, geographically diverse organisations; similarly, the resources that a firm can commit to the establishment, maintenance, modification and testing of its procedures - eg personnel, technology and/or financial resources - varies greatly. Clearly, managing policies and procedures in a broker-dealer is not a 'one size fits all' proposition. Most importantly, however, firms must take steps to ensure that their procedures respond appropriately to stimuli within their environment, ie to changes in rules and regulations, enforcement actions, litigations and/or changes in the business model of a firm (eg expansion of business lines).
Regardless of the size or complexity of a broker-dealer, effective management of procedures is critical and requires commitment. There are ongoing developments from numerous sources both inside and outside of a broker-dealer, and the impact of these on a firm's procedures must be considered. Effective management of a firm's procedures is a creative and interactive process that depends not only on the size, complexity and resources of a firm, but also on other intangibles, such as personalities, culture and attitude. What follows are only some of the different techniques that a firm can apply to help to manage this process (ie to create, maintain, update and test its procedures).
PART I: LAYING THE FOUNDATION - CREATING A COMPLETE SET OF PROCEDURES
Because a firm's procedures not only form the basis of how a firm supervises its business, but also serve as the foundation upon which future amendments, additions and revisions will be based, it is critical that a firm starts with a comprehensive, up-to-date set of procedures that provide for the appropriate supervision of its business. As discussed below, these procedures will need to be revised, amended and supplemented on an ongoing basis in response to changes that originate from both inside and outside the firm. If procedures are to be viewed as a living organism, an incomplete set of procedures will severely limit a firm's ability to adapt successfully to changes in its environment.
There are numerous alternatives available to firms to ensure that a complete set of procedures is in place. The method selected by a firm will often depend on the status of its current procedures. Firms with substantially complete procedures will want to retain and supplement, or revise, them to create a complete set. Firms with less complete procedures may decide to replace their procedures with an entirely new set of complete procedures.
Gap analysis
Firms with substantially complete procedures in place may consider conducting a 'gap analysis' to ensure that their procedures cover all required areas of supervision. Gap analysis involves matching the firm's existing procedures against applicable regulatory requirements. If no procedure exists to address a regulatory requirement, a gap will be found: new procedures will need to be created, or existing procedures revised, to close that gap. Gap analysis is one of the more common ways in which firms have assessed the completeness of their procedures.
Some firms have used the NASD's new member Written Supervisory Procedures Review Checklist ('WSP Checklist') to facilitate this exercise.11 On completing the analysis, the firm should have a complete set of procedures upon which to base future updates.
Replacement of existing procedures with new procedures
Firms that do not have an existing set of procedures to serve as a foundation, or those whose procedures may not be adequate or may not lend themselves to a gap analysis, may consider replacing their existing procedures with an entirely new set of supervisory procedures. The new procedures can be created using internal resources or obtained through an outside source (ie a law firm or other external vendor). Creating the procedures using internal resources will require substantial time and effort on behalf of firm personnel, which may be problematic for small firms. Using procedures obtained from an outside source will require less time and effort of internal personnel, but will entail a financial outlay.
Procedures that are available from outside sources can offer additional advantages. Many vendors have templates of procedures for almost every line of business in which broker-dealers may be engaged. Some of these products enable firms to customise the templates to their business through a 'Wizard'-type function. The procedures are specifically designed to cover NASD, NYSE, federal and other applicable laws and regulations. As such, they can help a firm to ensure that all applicable laws and regulations are addressed by its procedures. Moreover, some vendors have ongoing services that periodically provide suggested revisions and/or additions to their procedures, in response to new and amended regulatory requirements. These services can provide valuable assistance to firms in updating and keeping procedures current.
Care should be taken, however, when using an 'off-the-shelf' product or template that has been obtained from an outside source. These templates must be customised to the firm and its business lines. Regulators have made it clear that merely using an off-the-shelf version of procedures, without an appropriate degree of customisation to the firm, is unacceptable. Also, an off-the-shelf version of procedures may not match up to what is actually occurring within the firm. Having existing procedures that are not being followed invites a 'failure to supervise' finding by a regulator. In some cases, it is worse than having no procedures at all. At the very least, drafts of the procedures should be provided to appropriate legal, compliance and business personnel for their review, comment and revision, prior to the procedures' internal distribution and implementation. This process will facilitate a common understanding of the procedures within the firm and help build a commitment that they will be followed.
PART II: ESTABLISHING THE PROCEDURES - 'KEEPING THE MESSAGE ALIVE'
The challenge does not end with the creation of a complete set of procedures. It is critical for firm personnel to be, and to remain, familiar with its procedures. Accordingly, efforts must be made to familiarise employees with, and to stress the importance of, the procedures on an ongoing basis. As noted above, regulators will almost always demand copies of a firm's procedures during the course of an examination or investigation. They will compare those procedures to the information that they gather during the course of their examination, which will generally include interviews with a variety of firm personnel. It is not only embarrassing, but also potentially harmful to the outcome of an examination, for an employee not to be familiar with, or to misunderstand, a firm's procedures.
Procedures should be readily available to firm personnel for review and consultation. Traditionally, hard-copy procedures manuals have been provided to employees. Updates to the procedures have been distributed in hard-copy updates or as complete new procedures manuals. This has been an acceptable, if rather cumbersome, alternative for small firms who do not have access to more sophisticated means of distributing updates. It also encourages firm personnel to review the updates as they are received and incorporated into the firm's procedures manuals. A downside, however, is that it relies on employees to update their manuals. Failure of firm personnel to update their manuals will lead to different out-of-date versions of procedures being used within the firm. Printing and distributing hard-copy versions of the manual or procedures may also be costly and time-consuming. As a consequence, procedures may be updated less frequently than they should be.
If possible, procedures should be available electronically on the firm's intranet or website. Hosting a firm's procedures electronically on the firm's intranet or other website allows the firm to control the version of the procedures that is being used. This eliminates the danger of the retention of out-of-date versions. Firm personnel can be notified of updates through e-mails, easing the problems (eg of cost and frequency) that are associated with the distribution of hard-copy updates. This is particularly helpful for large firms that are geographically dispersed. Matters of importance or reminders regarding the procedures can be easily communicated. Where appropriate, personnel can be required to acknowledge that they have received and reviewed updates. Employee acknowledgements can be tracked. Importantly, use of these electronic tools creates an audit trail that enables a firm to document its procedures, each update to the procedures and their distribution to relevant personnel. This electronic alternative, however, will require financial, technological and employee resources that small firms may not have immediately at their disposal.
Firms should strongly consider providing training to employees in connection with their procedures, because this represents a unique opportunity to communicate requirements clearly. Training can be given in connection with specific procedures, updates and/or businesses as a firm sees fit. Firms will need to decide on what topics, and for whom, such training should be provided. Depending on the size and resources of a firm, there are a number of alternative methods through which to deliver training. While live training is effective and particularly attractive for smaller firms, it may pose issues for larger, geographically diverse firms. Conference calls, video conferences and/or webcasts can alleviate the restrictions that are inherent to live training. Firms with more resources may consider other electronic alternatives, such as web-based training modules. These can include a testing element, if appropriate.
The annual compliance meeting, or firm element training, is an opportunity that is often used by firms to remind employees of the importance of its procedures. Annual meetings between the
CEO and senior management are held in some firms, at which the importance of, and the ongoing responsibilities of senior management in relation to, procedures are discussed. Senior managers are then responsible for communicating this message to their business units. Firms can take the opportunity to incorporate communications relating to their procedures into the yearly employee-related reporting processes (eg those relating to outside business affiliations and personal accounts). Some firms require employees to make a 'sub-certification' in connection with the CEO certification process described above, which may include an acknowledgment that employees have read and understood its procedures.
The alternatives discussed above, along with many others, are available to firms to help them to establish their procedures and 'keep the message alive'. Firms should be creative in choosing which alternative works best for them given, among other things, their size, resources, complexity, business lines and geographical dispersion.
Evidence of compliance with supervisory procedures
The use of checklists or other evidence of supervisory review can help firms to keep personnel focused on their responsibilities. The administration of such programmes, however, can be time-consuming. Depending on the resources available, a firm might consider relying on electronic functionality to create, submit and track checklists, or other evidence of supervision, under its procedures. Such functionality might facilitate this process. Keep in mind, however, that the use of checklists can be extremely harmful to a firm if they are not properly completed. Regulators may view such a failure as evidence that a business is not being properly supervised.
PART III: ONGOING MAINTENANCE OF THE PROCEDURES - 'KEEPING UP WITH THE JONESES'
The creation of new procedures is just the beginning of the process. Maintaining current and effective procedures in a broker-dealer requires creative and effective management. Once a firm has established its procedures, the challenge becomes how to stay abreast of the overwhelming number of developments, from both inside and outside a firm, which may impact them. Keep in mind that a firm's procedures are a living, breathing thing that must adapt and evolve in response to changes in the firm's internal and external environment. Every day, the securities industry is full of data, news, developments, announcements, pronouncements and guidance, all of which potentially impact a firm's procedures. Likewise, changes within a firm must be carefully monitored (eg the opening of a new business line). Considering the pace at which change occurs, keeping up with all of these events poses an extremely difficult and time-consuming task. Nevertheless, these internal and external developments (stimuli) must be tracked and their potential impact on a firm's procedures evaluated on an ongoing basis. Failure to do so may lead to businesses that are not properly supervised. The following are some of the sources of events that may impact a firm's procedures and suggestions for managing them.
Regulatory developments: rulemaking; enforcement actions
The most obvious source of events that can potentially impact a firm's procedures are regulatory developments. Regulatory developments include, but are not limited to:
1. rulemaking by federal, state, regulatory and self-regulatory organizations (SROs), and other securities-related bodies;
2. enforcement actions by regulators;
3. other guidance issued by regulators (eg no-action letters, information memoranda, and interpretative releases).
Because regulatory developments will be the primary source of input that may lead to the revision of procedures and because of the fact that they occur at an alarming pace, these developments must be constantly monitored. Firms should consider how to resource this important function.
Whether the responsibility is vested in one individual, or several individuals across business and functional lines, it is essential that regulatory developments are watched and catalogued, and that their potential impact on a firm's procedures is carefully evaluated.
There are numerous sources that are available to firms to help them to monitor regulatory developments. There is a wealth of information available from the SEC, NYSE and NASD websites. Law firms typically publish regulatory updates that are also available on the Internet. Likewise, vendors provide services that are designed to capture all significant regulatory developments. Some of the same vendors discussed above, which assist firms in creating procedures, also provide suggested updates to the procedures on a periodic basis
(eg monthly, bimonthly). These updates reflect regulatory developments that impact a broker-dealer's supervision of business.
Firms must consider which of these alternatives will best leverage their resources. In making the determination, a firm should consider its structure, business lines and resources.
Regulatory examinations and inquiries
Broker-dealers are subject to ongoing inquiries, examinations and audits (ie regulatory reviews) from regulators, SROs and other membership organisations. The impact on a firm's procedures of the findings of these regulatory reviews, or of the issues raised during the course of these reviews, should be carefully considered. This is especially the case because regulators will typically follow up on what corrective measures, if any, have been taken by a firm in connection with such findings or issues raised. The failure of a firm to take appropriate action invites regulators to consider more severe findings or punishment. Indeed, the NYSE will take such matters into consideration when determining its recommended penalties. A good example of this can be found in a recent NYSE disciplinary decision involving Bishop Rosen & Co. Inc. The enforcement action originated from the findings of two prior examinations of the firm in 2002 and 2003. In reaching its decision, the hearing panel specifically took into account efforts that the firm had made in response to prior examination findings.12
Internal investigations/internal audit examinations
Similarly to the regulatory examinations/investigations discussed above, the effect of the results of internal audit examinations or other internal investigations on a firm's procedures should be evaluated. TheNYSE, in its Information Memorandum referenced above, stated that it would consider a firm's 'corrective measures', including improvement of procedures in response to the discovery of problems, in determining sanctions against a firm.13 Also, Mary Ann Gadziala, in the speech referenced above, stated that the SEC may consider limiting the scope of its examination of firms by 'leveraging off quality, effective internal audit work performed by firms'. She went on to say that:
[the SEC's] on the firm's own independent reviews will depend on whether examiners can be confident that effective independent oversight has been conducted and that the firm has taken meaningful corrective action.14
Litigation and other matters
Issues may arise in the course of litigations or other firm matters that may affect a firm's procedures. The impact of these issues must be considered.
New businesses or products
New procedures, or the revision of existing procedures, may be required to provide for the appropriate supervision of new businesses or products introduced at a firm. Accordingly, the launch of new businesses or products must be monitored. The NASD has provided guidance to member firms on best practices to be used in connection with the introduction of new products.15 Firms should consider development of regularised processes, such as the use of a 'new business committee', for the review and approval all new activity and/or products in a broker-dealer. Firms should consider whether the existence of appropriate supervisory procedures should be a condition of approval in such a process. At the very least, firms should take steps to ensure that new businesses and products are properly supervised, and that appropriate procedures are in place.
Ongoing testing of procedures
As referenced above, firms are required to conduct ongoing testing of the effectiveness of their procedures. The outcome of such testing will directly impact a firm's procedures. Firms are also required to have procedures that govern such testing. These testing procedures should include a means for the identification of areas that will be reviewed, and the prioritization and frequency of testing in those areas. Factors that may be considered in making this determination include:
previously identified issues;
size of business;
revenues; and
input from personnel (ie compliance, legal).
The testing procedures should provide the overall format or testing plan for the reviews. Generally speaking, testing should attempt to assess the effectiveness of the firm's procedures by comparing the procedures against business or functional unit practices and relevant rules. A schedule for conducting the reviews, assignment of responsibility for the reviews and reporting results of the reviews should also be included in the testing procedures. Any new businesses or products (as discussed above) should be added to the schedule for testing.
The results of the testing are required to be reported to the firm's CEO on an annual basis. Regulators may ask to review the results of the testing, as well as the firm's corrective action, if any has been taken in response to the results. Accordingly, it is critical that firms carefully consider the impact of the results of the testing on its procedures and take appropriate action.
PART IV: MANAGING THE FLOW OF INFORMATION
Perhaps the greatest challenge to maintaining effective procedures is the monitoring and evaluation of the many different sources of information that impact, or could potentially impact, a firm's procedures. As noted, the method by which a firm chooses to accomplish this objective is dependent on the size, resources and complexity of that firm. Whatever the method, however, it is essential that these sources are monitored on a continuous basis for matters that may warrant revision of the procedures. Understandably, such a responsibility may be overwhelming for only one person. Some firms have dedicated staff to handle this process; others have formed a committee to manage it. Members of such a committee typically include personnel from the principal business and functional groups within the firm. Committee members are responsible for monitoring and synthesising, on an ongoing basis, developments from various sources that may merit modification of the firm's procedures, and must report their conclusions to the committee for consideration. The committee meets periodically to consider any, and all, matters that may cause the firm to update its procedures. In effect, the committee acts as a 'safety net', designed to catch all developments that may impact the firm's procedures. Committee members are generally responsible for reviewing and approving proposed revisions to the procedures. At a larger firm, members might include representatives from the following groups:
legal;
compliance;
finance;
operations;
equity sales and trading;
fixed income sales and trading;
investment banking;
research;
tax;
structured products;
internal audit; and
technology
Responsibilities are assigned to each of the committee members. For example, the representatives from legal and compliance may report on significant regulatory developments, regulatory exam findings and litigation issues; the business groups would address any planned new business and/or products. All of the members should report on any issue or matter that comes to their attention that may impact the firm's procedures. In order to manage this process properly, a clear agenda should be set. The committee as a whole should discuss the impact of all developments. Specific business or functional units impacted by a development should play a major role in the creation or revision of procedures in response to the development (eg in relation to
Regulation NMS: equity sales and trading; operations; technology; legal; compliance). Responsibilities should be clear and assigned.
PART V: COMMUNICATION OF CHANGES AND VERSION MANAGEMENT - 'THE FINAL FRONTIER'
Once a firm's procedures have been revised, a process should be in place to distribute the revisions to affected firm personnel. As discussed in greater detail in Part II, this process can be managed in a number of different ways. Depending on resources, hard copies may be distributed. At other firms, revisions may be distributed electronically as bulletins and posted on the firm's intranet. In either case, arrangements must also be made to archive retired procedures.
Electronic application
Some firms use an electronic application to manage the publication, distribution and archiving process. The application assists firms in creating, publishing and maintaining existing procedures, and in creating and distributing revised procedures. The application also houses archived versions of the procedures. It allows authorised users to distribute the revised procedures to firm personnel and to track receipt. When revised procedures are created, the procedures being replaced are electronically dated and archived within the application for future reference.
Documentation of processes
However a firm chooses to manage its procedures, the process should be appropriately documented. Should an issue arise, regulators will want to see evidence of a thoughtful and reasoned approach to the establishment, maintenance, review, testing and modification of the firm's procedures.
A FINAL NOTE: COMMITMENT - 'IT DON'T MEAN A THING, IF IT AIN'T GOT THAT SWING'
In light of the tremendous effort required, the effective management of a firm's procedures will not be possible without the ongoing commitment of the firm and its personnel. Without such commitment, this objective will be lost in the day-to-day struggle to compete in the broker-dealer world. The approach taken by a firm to maintaining this commitment will vary with its personality. At the very least, there should be buy-in at the level of senior management.
Employees should be reminded of the senior management's commitment periodically. Appropriate resources should be made available with which to manage the process effectively. Personnel might be rewarded, or recognised, for their efforts. Although it is an overused phrase, regulators are not mistaken in regularly urging firms to adopt a 'culture of compliance'.16 But this should not be misconstrued as a suggestion that business be inappropriately restrained within a firm; rather, it should be interpreted as succinct and valuable guidance that a firm-wide commitment is critical to the effective management of procedures.
CONCLUSION
Procedures appear to be, then, a living, breathing thing. They demand constant attention and nurturing. They must evolve and adapt to the ever-changing environment around them. Above all, they require commitment: if they are not nurtured, if they do not evolve and adapt, they will fail to serve the purpose for which they were created - the effective supervision of the firm.
The methodology used by a firm to tackle the challenge of effectively managing its procedures will vary with the personality of the organisation. This is a task that demands creative and innovative solutions, tailored to the size, complexity, resources, personality and culture of a firm.
REFERENCES
(1) 15 USC s78o.
(2) Ibid.
(3) See NYSE Rule 342 and NASD Rules 3010, 3012 and 3013.
(4) Ibid.
(5) See Thomas M Ruddy, NYSE Hearing Board Decision 07-089, 11th July, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#07-089).
(6) Schon-Ex LLC, NYSE Hearing Board Decision 06167, 12th December, 2006.
(7) Piper Jaffray & Co., NYSE Hearing Board Decision 07082, 31st May, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#07-082).
(8) James P Dalton, NYSE Hearing Board Decision 07-075, 22nd May, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#07-075).
(9) NYSE Information Memorandum 0577 Factors Considered By The New York Stock Exchange Division Of Enforcement In Determining Sanctions, 7th October, 2005.
(10) Mary Ann Gadziala, associate director, US Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations (2007) The Regulatory Focus on Broker-Dealer Legal and Compliance Issues, Speech to the Securities Industry and Financial Markets Association (SIFMA) Legal and Compliance Division, 7th June, available online at http://www.sec.gov/news/speech/2007/spch060707mag.htm.
(11) Available online at http://www.nasd.com/web/groups/corp_comm/documents/home_page/nasdw_009839.pdf.
(12) Bishop Rosen & Co. Inc., NYSE Hearing Board Decision 0695, 1st February, 2007 (online at http://www.nyse.com/DiscAxn/discAxn_07_2007.html#06-095).
(13) NYSE Information Memorandum 0577, supra.
(14) Gadziala, supra.
(15) NASD Notice To Members 0526 NASD Recommends Best Practices For Reviewing New Products, April 2005, available online at http://www.finra.org/RulesRegulation/NoticestoMembers/2005NoticestoMembers/p013756.
(16) David Glauber, NASD chairman and CEO (2004) Update From NASD, Speech at the Securities Industry Association (SIA) Annual Conference, Boca Raton, FL, 4th November.
