Trading broker and clearing broker dealer vs introducing
In such cases, the omnibus accountholder - i. Referring to the legislative history of the PATRIOT Act, the preamble states that it is the plan that is the fund's customer, not the individual plan participants. In most instances, given Treasury's risk-based approach to anti-money laundering programs for financial institutions generally, it is expected that the focus of each futures commission merchant's and introducing broker's CIP will be the intermediary itself , and not the underlying participants or beneficiaries.
We believe this same risk-based approach to intermediary relationships should be extended to broker-dealers. Just as in the mutual fund and futures business, it is commonplace for broker-dealers to maintain accounts for intermediaries that trade on behalf of third parties, such as other broker-dealers, banks, mutual funds, pension funds, and investment advisory firms.
These intermediaries are often large, well-regarded, publicly traded and highly regulated entities. Such an approach also takes into account the serious proprietary and privacy issues that arise in the context of intermediated relationships. For example, an intermediary is often unwilling to disclose the identity of its clients to the broker-dealer whom the intermediary often regards as a competitor.
Indeed, the very structure of the transaction highlights the fact that the intermediary does not want its customer to be viewed as a customer of the broker-dealer.
Thus, if the intermediaries are properly reviewed, reliance on such intermediaries not only is appropriate, but essential to conducting business across borders. While the breadth of relationships with intermediaries is extensive, the following are examples of routine transactions involving intermediaries that have undertaken prior identification and verification of their own customers: In this type of business, the securities are not held in the account at the broker-dealer but delivered out to a bank as custodian.
Thus, the broker-dealer holding the omnibus account is not really "carrying" the intermediary's account in the traditional sense, as it is not maintaining custody of cash or securities, nor providing margin financing to the account.
It is only facilitating a brokerage transaction. Given this structure and the fact that DVP business generally presents very little risk of money laundering, we believe a severe burden and unnecessary business disruption would be imposed on this type of business, which encompasses a large volume of institutional securities trading activity, if a broker-dealer were to have to go beyond verifying the identity of the intermediary.
It is also critically important that a firm be allowed to treat an intermediary as its customer for section purposes even when it establishes administrative subaccounts to facilitate transactions with the intermediary. In this regard, it is common practice for firms that do institutional business to open both an omnibus account for the institutional intermediary, as well as administrative subaccounts for the intermediary's clients.
However, in some cases the subaccounts are identified by number, in others they may contain the client's name and the name of the client's custodial bank or broker-dealer. In addition, most such subaccounts are set up through the use of automatic data feeds from third-party vendors. The practice of setting up administrative subaccounts is essential to the operation of institutional business in the securities industry, and virtually every institution avails itself of these automated third-party systems.
Because the type of information received is extremely limited, if these subaccounts were considered accounts for purposes of section , thus requiring firms to collect additional information about and verify the identity of the intermediary's client, institutional business would effectively be brought to a halt.
Firms simply could not obtain documentary numbers and verify the required information within the time frames necessary to handle their institutional transactions, and the costs of doing so would be enormous, particularly since the use of automated data feeds would almost certainly be eliminated by a verification requirement. Accordingly, we urge the agencies to provide guidance in the final rule that the establishment of such institutional subaccounts does not trigger any obligation by the firm to verify the intermediary's underlying client.
In short, under Treasury's risk-based approach, a broker-dealer should be permitted to treat the intermediary as its customer and should not have to "look through" the intermediary to identify or verify the clients on whose behalf the intermediary is acting, so long as appropriate due diligence has been conducted on the intermediary. Accordingly, we suggest that the preamble include the following language, similar in concept to the language in the preamble to the proposed rule for FCMs and IBs: In most instances, given Treasury's risk-based approach to anti-money laundering programs for financial institutions generally, it is expected that the focus of each broker-dealer's CIP will be the intermediary itself, and not the underlying participants or beneficiaries.
Specifically, a broker-dealer should be able to make an assessment of whether it can rely on the verification done by an affiliate, such as an affiliated bank, broker-dealer or investment advisor. For instance, where a bank and broker-dealer are affiliated, and both subject to similar verification procedures, it makes little sense not to allow them to rely on verification performed by an affiliated entity.
In these situations, if firms are not permitted to rely on affiliates, customers will have to provide the identical information multiple times. Most significantly, no legitimate anti-money laundering purpose is served by requiring affiliated entities to each perform the same verification on the same customer. We also note that the proposed rule for FCMs recognizes the need to avoid duplication for firms that have both a broker-dealer and a futures commission merchant or introducing broker.
Shared Account or Client Relationships We appreciate that the proposed rule recognizes that broker-dealers that share an account relationship with the same customer should be able to allocate between themselves the responsibility for verifying the customer's identity. This approach avoids unnecessary duplication of effort while at the same time provides adequate assurance that customer verification obligations will be met.
We respectfully request, however, that the proposed rule provide more specific guidance with respect to the following types of shared relationships, which we address in more detail below: We appreciate that, in the proposed rule relating to CIPs for broker-dealers, Treasury and the SEC recognized that the structural relationship between an introducing broker and a clearing broker raises unique issues. We respectfully request that, as discussed more fully below, the agencies clarify certain issues relating to introducing brokers and clearing firms in the final rule.
Our concerns are best understood in light of the history of the development of the structural relationship between introducing brokers and clearing brokers. We have therefore set forth in the attached Appendix a description of the background and basic structure of the introducing firm-clearing firm relationship. Sharing of Responsibilities for Verification of Identity Our threshold comment relates to language in the preamble to the proposed rule which indicates that broker-dealers will be able to share responsibilities under section when one or more brokers is involved with a customer's account.
For example, the correspondent may undertake to obtain the identifying information from customers. Nonetheless, both firms would still be responsible for ensuring that each requirement in the rule is met with respect to each customer. We note, however, that the example cited in the preamble to the proposed rule regarding the allocation of responsibilities, i. As the background discussion in the Appendix makes clear, the customer contact role lies primarily with the introducing broker.
As the initiator and manager of the customer relationship, the introducing broker is in the best position to obtain the documentary number and verify the information through the use of physical documents i. In contrast to these document-based "positive verification" efforts, the clearing firm is well-positioned to perform a non-documentary "negative verification" function, i.
Accordingly, the example in the preamble to the proposed rule should be modified to reflect that "the correspondent may undertake to obtain identifying information from customers as required in paragraph c and undertake the positive verification procedures and the clearing firm may undertake the negative verification procedures. Specifically, the relevant text of the rule defines "customer" as "[a]ny person who is granted authority to effect transactions with respect to an account with a broker-dealer.
In that context, the clearing broker receives its instructions directly from the introducing broker and has no knowledge of the person or persons authorized to trade on behalf of the end customer. In fact, the decision whether to accept a trade i. These examples underscore the importance of the fact that the final rule should specifically leave it to the parties to allocate or apportion their responsibilities, including verification responsibilities, consistent with their contractual relationship as approved by their functional regulators.
The language in the preamble to the proposed rule with respect to the apparent responsibility placed on both firms for ensuring that " each requirement in the rule is met with respect to each customer " 18 raises concerns in this regard.
We believe this language is at odds with the fundamental concept of permitting the allocation or apportionment of responsibilities between an introducing broker and its clearing firm. Where the parties have apportioned specific responsibilities pursuant to a contractual agreement, each should be held responsible for satisfying their respective obligations. Indeed, the purpose underlying such an arrangement is to document and confirm that the responsibilities have been sufficiently allocated between an introducing broker and clearing broker and that each is aware of the responsibilities it is expected to perform - not that both are responsible for the performance of all functions with respect to each customer.
For example, where an introducing broker has represented to the clearing firm that it has verified employment information or other data received from the customer, either through contact with the customer or through a credit information service vendor, the clearing firm should be able to rely on those representations. Conversely, where a clearing firm has represented to the introducing broker that it has scanned a name through its screening process, the introducing broker should not have to duplicate that process.
As these examples make clear, the measure of responsibility, as between an introducing firm and a clearing firm, should be that each has been apportioned a particular part of the process for which it is fully responsible, not that both are to be held responsible for fulfilling each and every requirement with respect to each customer.
We believe it would be best for the functional regulators to be given the flexibility to determine the responsibilities that should be owed to "each customer" by each of the respective entities based upon their structural functions. We respectfully suggest that by seeking to broaden each entity's responsibility, the proposed rule is changing the entire regulatory scheme in the area of introducing-clearing firms which has been adopted by the securities regulators, and which has worked successfully for many years.
Each firm would be responsible for ensuring that its respective obligations are carried out. Absent an indication that reliance on the other firm is unreasonable e. Such a certification would be consistent with the language in the preamble requiring a broker-dealer to "continually assess whether the other firm can be relied on to perform its responsibilities.
As in any other omnibus relationship see discussion above , because the clearing broker will typically have little or no identifying information for the introducing firm's customers, the final rule should reflect that a clearing broker's CIP need not include procedures to identify or verify the identity of those customers whose transactions are cleared through an omnibus account.
Indeed, the companion rules applicable to mutual funds and futures commission merchants "FCMs" and futures introducing brokers "IBs" expressly recognize that those respective entities are not expected to verify the identities of individuals whose transactions are conducted through an omnibus account. This should include transactions for omnibus accounts opened by, or maintained in the name of, an introducing firm.
We therefore suggest that the language in the proposed rule for broker-dealers be harmonized with the language in the proposed rule for FCMs and IBs 22 and the proposed rule for mutual funds 23 to make clear that the institution having the omnibus relationship should be the focus the clearing broker's CIP. Thus, assuming that the clearing broker conducts its due diligence on the introducing firm, such efforts should be sufficient to meet its regulatory obligations.
Accordingly, we suggest that the preamble to the proposed rule be revised to include the following language: Typically, the clearing broker has little or no information for the individual customers of the introducing firm represented in an omnibus account. This rule does not require that a clearing broker obtain any additional information regarding the identities of the individual customers of the introducing firm whose transactions are conducted through the omnibus accountholder.
Of course, the omnibus account holder is itself a customer of the clearing broker for purposes of this rule. In assessing the introducing firm, a securities clearing broker could assess the risks associated with different types of introducing firms based upon an evaluation of relevant factors, including the type of introducing firm; its location; the statutory and regulatory regime that applies to that particular introducing firm, such as whether the jurisdiction complies with the European Union anti-money laundering directives or has been identified as non-cooperative by the Financial Action Task Force; the clearing broker's historical experience with the introducing firm; references from other financial institutions regarding the introducing firm; and whether the introducing firm is itself a financial institution subject to the Bank Secrecy Act "BSA" and required to have an anti-money laundering program.
In contrast, the rule, as proposed, states that a securities broker-dealer's CIP would be based on, among other things, an assessment of "[t]he broker-dealer's reliance on another broker-dealer with which it shares an account relationship.
We request that the final rule acknowledge that responsibilities can be allocated or apportioned between such entities consistent with NYSE Rule or NASD Conduct Rule , and that the proposed rule be clarified to permit the sharing and allocating of responsibilities between a clearing broker and a foreign financial institution acting as an introducing firm regardless of whether the foreign financial institution is registered with the SEC.
Such an arrangement would be appropriate where the clearing broker has conducted its own due diligence on the foreign introducing entity in accordance with the criteria discussed above. However, we believe that allocation of customer verification obligations is equally appropriate in other types of shared account or client relationships, such as prime brokerage arrangements, and we recommend that such a reference be added in the preamble to recognize that such sharing is appropriate in other types of relationships.
A prime brokerage arrangement allows investors who maintain a primary account relationship with one broker-dealer the "prime broker" to have individual trades executed with another broker-dealer the "executing broker" and cleared and settled into their custody account with the prime broker.
Most investors who use such arrangements are sophisticated market participants such as institutions and investment management firms. Like clearing arrangements, prime brokerage relationships are governed by a contract between the prime and executing brokers that specifies the obligations and responsibilities of the parties. There are also agreements between the customer and the prime broker, and the customer and the executing broker, in which the customer acknowledges the different responsibilities undertaken by each of the two brokers.
In addition, the prime and executing brokers must comply with strict requirements set forth in various SEC no action letters and their compliance with such requirements is overseen by self-regulatory organizations.
Prime brokers and executing brokers that "share" accounts or clients would realize similar efficiencies as clearing and introducing brokers by dividing up the requirements of the rule. Of course, as with clearing arrangements, the broker's reliance on one another must be reasonable.
Our firms' experience is that increasingly securities transactions occur through an evolving combination of regulated financial institutions. The rule should therefore permit the allocation of the identification requirements where more than one financial institution may be involved in servicing a customer account.
This approach would avoid a duplication of effort and allow institutions the flexibility to apportion the requirements according to the nature of the customer relationship. Of course, the allocation of duties must be reasonable in light of the nature of the relationship of each institution to the customer. Thus, a financial institution should be able to rely on another regulated financial institution's certification that it has satisfied the CIP requirements. Other Clarifications Requested Verification of Public Corporations The sixth risk factor to be considered by a broker-dealer is "the customer base" and Treasury appropriately notes that a closely held corporation may pose greater risks than a publicly traded corporation.
Instead, we suggest that subparagraph ii incorporate additional examples that would be more appropriate for verification of a public corporation, such as the use of public databases e. Identification Numbers For Foreign Institutions The agencies seek comment on the use of documentary numbers for non-U. Paragraph c 1 iv B of the proposed rule requires broker-dealers to obtain from all non-U. While these types of identification numbers appear suited to non-U.
Accordingly, the rule should be revised to reflect the unavailability of such information. Recordkeeping Requirement We believe the rule should provide additional clarification as to the types of records that must be maintained when verification is done by checking public databases or those databases maintained by third-party vendors.
As drafted, the rule requires a broker-dealer to make records of the "methods and results of any measures undertaken to verify" through non-documentary methods. However, it is unclear how a firm might satisfy this requirement when it uses certain types of non-documentary verification methods that do not necessarily result in a documentary record. For instance, there is no documentary record where a search of a public database fails to turn up any negative information.
Similarly, where a firm uses a third-party vendor database, the firm may not receive a record where the search did not uncover any negative information. We think broker-dealers should be able to satisfy this obligation in various ways other than a traditional documentary record. For example, we suggest that when a firm performs a negative database search, it would be sufficient to maintain some form of record showing the account numbers that were run through the search and any account numbers that came back with positive "hits.
Because many firms will use third-party vendors for verification checks, we suggest that the agencies make clear that firms are permitted to contract with these outside vendors to maintain the records showing the results of searches. Firms would have to arrange with these vendors so that such documentation would be available for regulatory purposes.
Application of the FCRA to Verification Decisions The proposed rule strongly endorses the use of non-documentary methods to verify customers, in particular the use of public and private databases.
Indeed, the rule requires firms to use such methods in certain situations, and the preamble notes that, in many ways, such methods are superior to traditional documentary methods. We concur in the agencies' views on this. Many of our members believe that the use of databases to verify customers will be one of the most - if not the only - cost-effective and practical methods for complying with the new requirements in non face-to-face account openings.
We are concerned, however, about the possible application of the Fair Credit Reporting Act "FCRA" to the use of such databases for verification purposes. To the extent the FCRA were held to apply, it would impose significant obligations on both the firms using the databases and the database vendors that could potentially undermine the availability and effectiveness of such methods.
In addition, many database vendors include provisions in their subscription agreements prohibiting subscribers from using their information for any purpose covered by the FCRA. In order to avoid these problems, we urge the agencies to take the necessary steps to provide some form of exemption from the FRCA for the use of public or private databases to comply with Section obligations. Burden Imposed By the Rule Although we are not challenging the rule on the basis of burden, we believe that the rule drastically underestimates the burden that will be imposed by the proposed procedures.
The Commission also estimates that obtaining the required minimum identifying information will take approximately one minute per account, and that the average time spent verifying an account will be five minutes. We believe that the time and cost of establishing and implementing the required customer identification programs, and obtaining the required information and verifying each account will be well beyond the estimates in the rule.
If you wish to receive additional information related to our comments, please feel free to contact the undersigned. Via Electronic Mail Michael A. Securities and Exchange Commission Randall W. Roy Division of Market Regulation U.
This provision is included in the actual terms of the proposed rule applicable to banking organizations, but is only included in the preamble to the broker-dealer rule. Including this provision in the text of the rule itself will add clarity to the rule, and help ensure that firms are not redoing verification -- and thereby misallocating resources -- for existing customers for which such procedures are not required. Scope of Verification Duty Our understanding is that paragraph d of the proposed rule does not require a broker-dealer to verify every piece of identifying information obtained from a customer, but rather to verify enough information to reach a reasonable belief that it knows the customer's true identity.
It would be helpful if this were stated more clearly in the preamble, as it is in the preamble to the proposed rule for mutual funds. Banks are required to do so only when "the type of account" increases this risk. IBs do not actually hold customer funds to margin. They advise commodity pools and offer managed futures accounts. CTAs exercise discretion over their clients' accounts, meaning that they have power of attorney to trade the clients account on his behalf according to the client's trading objectives.
A CTA is generally the commodity equivalent to a financial advisor or mutual fund manager. A commodity pool is essentially the commodity equivalent to a mutual fund. This is the commodity equivalent to a registered representative.
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