The U.S. Securities and Exchange Commission (SEC) published a report Thursday that examines the efforts or broker-dealers to protect confidential information from misuse, such as insider trading — indicating that it found gaps in firms’ procedures.
The staff report by the SEC’s Office of Compliance Inspections and Examinations aims to help broker-dealers safeguard confidential information, and highlights the findings of its review of how firms keep “material nonpublic information” from being misused.
The report indicates several areas of concern stemming from its review. For example, it notes a “significant amount of informal, undocumented interaction” occurs between groups that have sensitive information, and internal and external groups with sales and trading responsibilities that might profit by exploiting the information.
Also, it notes that, at some firms, a senior executive might have access to material nonpublic information from one business unit while overseeing a different unit that could potentially profit from that information, with few restrictions, and no monitoring, to prevent misuse.
And, it says that some brokers did not have adequate risk controls in certain areas, such as sales, trading or research personnel who receive confidential information; clients or asset management affiliates with access to inside information; or, employees who receive information through outside activities, such as participating in bankruptcy committees or serving on public company boards.
“The staff identified gaps in oversight coverage at most broker-dealers, although such gaps differed,” the report notes. And, while it says the gaps it found do not necessarily mean that rules are being violated, “broker-dealers may find it helpful to consider them in reviewing their policies and procedures.”
The report also highlights effective practices that SEC examiners observed at some broker-dealers, such as: adopting processes to differentiate between types of material nonpublic information, based on the nature of the information, or its source; expanding reviews for potential misuse of confidential information to include trading in a broader range of securities, including credit default swaps, loans, components of pooled securities, warrants, and bond options; monitoring electronic sources of confidential information; and ensuring that only authorized personnel can access sensitive areas.
This report should help broker-dealers assess the effectiveness of their controls over sensitive information,” said Carlo di Florio, director of the SEC’s OCIE. “The report illustrates the types of conflicts of interest that may arise between a broker-dealer’s obligations to clients that provide confidential information for business purposes and the potential misuse of such information for insider trading or other improper ends. It also describes various methods that broker-dealers use to identify and effectively manage such conflicts, including information barriers that limit the flow of sensitive information.”