[ by Howard Haykin ]

The SEC on Thursday opened its books - or at least its "Staff Summary Report on Exams of Information Barriers: B/D Practices...", a 52-page report by the Office of Compliance Inspections and Examinations (OCIE).

The report is intended to help broker-dealers safeguard confidential information from misuse - e.g., insider trading - and provides a compendium of methods and strategies - strong and weak - that different broker-dealers use to control material nonpublic information so as to prevent it from being misused. 

OCIE Director Carlo di Florio had this to say:  "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.”

Some Conflicts of interest (COIs) and other issues of concern raised by the report, include:

• Instances where there are significant amounts of informal, undocumented interaction between:  (i) groups that have material nonpublic information;  and, (ii) internal and external groups with sales and trading responsibilities that might profit from the misuse of such material nonpublic information.

• In some cases, a senior executive of a broker-dealer might have access to material nonpublic information from one business unit while overseeing a different unit that could potentially profit from misuse of that information, with few if any restrictions or monitoring to prevent such misuse.

• Instances where broker-dealers do not have risk controls to address certain business units that possess material nonpublic information - e.g., (i) sales, trading or research personnel who receive confidential information for business purposes; (ii) institutional and retail customers or asset management affiliates with access to material nonpublic information, or, (iii) firm personnel who receive information through business activities outside of investment banking, such as participation in bankruptcy committees or through employees serving on the boards of directors of public companies.

The report highlights effective practices that examiners observed at some broker-dealers, including the following:

• Some firms adopted processes that differentiate between types of material nonpublic information, based on the nature of the information or where it originated.  Some broker-dealers create tailored “exception” reports that take into account the different characteristics of the information.

• Some firms expanded the scope of reviews for potential misuse of confidential information:  e.g. - they'd cover trading in credit default swaps, equity or total return swaps, loans, components of pooled securities - e.g., UITs and ETFs, warrants, and bond options.

• Firms often considered electronic sources of confidential information, and established procedures for identifying those employees with access to the information.

• Firms often monitored access rights for key cards and computer networks to confirm that only authorized personnel had access to sensitive areas.

The types of issues identified in the report can be helpful while firm personnel review the firm's conflict of interest risk management programs. And, during any review of information barriers control programs, it is critical to be alert to the possible impact of changes in business practices, changes in personnel responsibilities, and available compliance tools.

OCIE Staff Credits.  Christine Sibille in the Washington D.C. office had a key role in producing the report.  Staff members who worked on exams that provided the underlying content of the report, included:  Roberta Boyd, Jane Cash, Michelle Davis, Everardo DeArmas, Juanita Hamlett, Wanda Hunter, Judy Lee, Danielle Perfetuo, and Lisa Wardlaw in the Washington, D.C. office; and Claudia Arroyo, Theresa Gleason, Stephanie Morena, John Nee, and Hermann Vargas in the NY Regional Office.

For further details, go to:   [SEC PR 12-200, 9/27/12] and [Staff Report, 9/27/12].