CBOE issued a circular to CBOE, C2 and CBSX Trading Permit Holders in advance of new market access requirements set forth in SEC Rule 15c3-5.  The rule is scheduled for 7/14/11, and TPH's must have the required controls and procedures in place by that time.

General Overview of Rule 15c3-5.   Adopted on 11/3/10, new SEC Rule 15c3-5 requires a broker-dealer with market access to an exchange or alternative trading system, or that provides a customer or any other person with access to an exchange or ATS through use of its market participant identifier or otherwise, to establish, document, and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory, and other risks of its business activity.

• “Market Access” defined as “(i) access to trading in securities on an exchange or alternative trading system as a result of being a member or subscriber of the exchange or [ATS], respectively; or (ii) access to trading in securities on an [ATS] provided by a broker-dealer operator of an {ATS] to a non-broker-dealer.”
• The Rule applies to transactions by all B/D's with market access, and does not distinguish between transactions for the proprietary account of the B/D - including market making activities - or for more traditional agency activities.
• By virtue of its requirements, the Rule prohibits B/D's from providing “unfiltered” or “naked” access to an exchange or ATS.

Risk Management Controls and Supervisory Procedures.   As written, risk management controls and supervisory procedures must include the following elements:

• Financial Risk Management Controls and Supervisory Procedures -  reasonably designed to systematically limit the financial exposure of the broker or dealer that could arise as a result of market access, including being reasonably designed to:
  • Prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds in the aggregate for each customer and the broker or dealer and, where appropriate, more finely-tuned by sector, security, or otherwise by rejecting orders if such orders would exceed the applicable credit or capital thresholds; and
  • Prevent the entry of erroneous orders, by rejecting orders that exceed appropriate price or size parameters, on an order-by-order basis or over a short period of time, or that indicate duplicative orders.

The financial risk management controls and supervisory procedures described above must be under the direct and exclusive control of the broker-dealer with market access.

• Regulatory Risk Management Controls and Supervisory Procedures - reasonably designed to ensure compliance with all regulatory requirements, including being reasonably designed to:
  • Prevent the entry of orders unless there has been compliance with all regulatory requirements that must be satisfied on a pre-order entry basis;
  • Prevent the entry of orders for securities for a broker or dealer, customer, or other person if such person is restricted from trading those securities;
  • Restrict access to trading systems and technology that provide market access to persons and accounts pre-approved and authorized by the broker or dealer; and
  • Assure that appropriate surveillance personnel receive immediate post-trade execution reports that result from market access.

The controls and procedures described above must be under the direct and exclusive control of the B/D with market access. However, Rule 15c3-5 provides that a B/D with market access may reasonably allocate, by written contract, after a thorough due diligence review, control over specific regulatory risk management controls and supervisory procedures to a customer that is a registered B/D, provided that such B/D with market access has a reasonable basis for determining that such customer, based on its position in the transaction and relationship with an ultimate customer, has better access than the B/D with market access to that ultimate customer and its trading information such that it can more effectively implement the specified controls or procedures. Rule 15c3-5 further provides that any such allocation of control shall not relieve a B/D with market access from any obligation under the Rule, including the overall responsibility to establish, document, and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory, and other risks of market access.

• Regular Review of Controls and Supervisory Procedures.   To continue reading this section and additional information and other considerations, go to:   [CBOE RegCirc 11-65, 5/26/11;  C2 RegCirc 11-4, 5/26/11]