Examinations of proprietary trading broker-dealer organizations by CBOE’s Department of Member Firm Regulation has found instances where individual sub-accounts appear to be beneficially owned by persons who should be treated as customers, rather than as members/traders of the B/D.  This issue can be a particular issue for prop trading B/D's that are structured as LPs and/or LLCs, and which offer master and sub-account arrangements.

The exams have shown that the prop trading firms do not treat these accounts as customer accounts, and consequently the accounts are not afforded the protections associated with customer accounts.  While CBOE recognizes that there are bona fide reasons to establish master/sub-account arrangements whereby some beneficial owners maintain multiple sub-accounts - e.g., to employ and monitor different trading strategies, or to trade in different types of securities - DMFR advises members that these accounts should be treated as customer accounts, rather than as prop accounts of the broker-dealer. 

These rules apply to both non-clearing proprietary trading broker-dealers and clearing broker-dealers. Additionally, a clearing broker-dealer is not relieved of responsibility by the mere fact that it does not offer sub-accounts.  If the clearing broker-dealer is or becomes aware that its clients break an account or accounts into sub-accounts, they should review the activity as if the clearing broker-dealer was offering sub-accounts, as discussed in CBOE's release. 

    What Non-Clearing B/D Should Do.   To demonstrate that persons or entities that have provided the non-clearing broker-dealer with cash are owners and not customers, the B/D must do the following:

• Prepare complete paperwork for all class members, including signed LLC agreements and traders agreements which provide a clear description of the relationship between the B/D and trader/member and that:  (i) capital contributions must be locked-up for 1 year;  and  (ii) funds invested as capital are subject to all the risks of the B/D, including risks related to other trader losses.
• Document the source of account funding and profit and loss splits - a split which provides all or virtually all of the P & L to the trader is likely a red flag that the account is a customer account.
• Monitor and supervise the activity in each account, which includes the authorization and establishment of trading privileges.
• Have all persons associated with the B/D complete an employment application, and all individuals associated with the B/D, except for those whose job functions are clerical or ministerial in nature, must be fingerprinted and have such fingerprints submitted to the DOJ for a criminal background check.
• Conduct a pre hire check of all associated persons using the WebCRD BrokerCheck program.
• Have all persons associated with the B/D appropriately registered with each SRO of which they are a member or TPH in accordance with the rule of each SRO of which they are a member.

For further details, refer to:   [Reg. Circ 10-101, 10/1]