Category: Resources

In this post credit crunch era of modern banking, regulators continue to struggle to determine the most effective penalty for banking institutions found guilty of malfeasance. Historically, the most popular form of punishment has been to levy a fine. For many financial institutions though, regulatory fines have simply become a cost of doing business. This issue has lead regulators to wonder if there might be a more effective penalty that would serve as a better deterrent.

It’s no surprise that regulatory fines are frequently the first line of defense, so to speak, when it comes to banking regulation. The idea of an eye for an eye is fundamentally as old as humanity, and there is some psychological sense in the logic of attempting to make the victim of the crime feel somewhat whole. In fact for many smaller, regional banks a regulatory fine might be the most suitable course of action. Retail banks are generally built on a basis of a personalized trust. The clients of the bank want to feel that the bankers are working in their best interest, and indeed that personalized trust is frequently the reason that the client has chosen that institution over a larger, international institution in the first place.

However, the fines alone are still quite frequently not enough. It is the resulting public relations repercussions that usually have the most impact on the bank and its reputation. In fact, following the credit crunch, some of the smaller mortgage lenders were never able to recover from the loss of business and ended up drastically cutting operations or shuttering their businesses completely. It is the resulting reputational risk that is the true regulation that keeps most companies on the straight and narrow.

For larger multinational corporations, the issue can be a bit more complicated. Generally speaking, these companies can afford to maintain larger legal, PR and marketing departments in order to fight the reputational risk.

Furthermore, a million dollar fine could feel like a mere drop in the bucket for a firm with billions of dollars in assets under management. Certainly with such a small amount of skin in the game and a large war chest to fight the battle, a fine alone may not be enough to corral larger institutions.

In the recent case of a French banking giant some outside the box thinking has taken the form of a ban on dollar clearing. The bank has recently pleaded guilty to charges of hiding transactions from blacklisted nations. Since this is not a first time US banking sanctions offense for them, regulators decided to institute a one year ban on certain dollar clearing transactions. The regulatory action could have a ripple down effect for clients of the bank and potentially impact the revenue stream of the bank directly by essentially making it impossible for some domestic and international clients to continue doing business with the bank.

This case has garnered a lot of attention from the financial world and beyond. Banking officials and regulators have been watching the case closely and will likely continue to do so as the year progresses. If nothing else, this landmark case will go a long way in showing that regulatory fines alone may not be enough anymore. Going forward, the fines will need to be backed by regulatory imposed changes, market order limitations and more stringent penalties in order to be effective.

As part of the Securities Exchange Act of 1934, SEC Rule 17a-3 governs record-keeping in relation to broker dealer trade communications. In this modern age of information both the velocity and complexity of these communications have increased exponentially, and many financial firms have found themselves struggling to find usable solutions for compliance with Rule 17a-3.

Following the events of September 11th, 2001 SEC Rule 17a-3 suddenly and dramatically became a growing concern for an increasing number of financial clients. When the World Trade Centers collapsed, they took with them a massive volume of financial records (both printed paper and electronically stored). What had formerly been the realm of back office auditors and regulators, came to the forefront of conversations within the executive suite. For some small and mid-level firms the operational devastation became too big of a hurdle to overcome, and those firms found themselves in the unfortunate position of being unable to re-establish trading operations. Meanwhile, larger firms with bigger war chests set about the arduous task of establishing a decentralized datacenter storage facility as a key component of a larger business continuity and disaster recovery plan.

However, the task of record-keeping is not always as easy as simply gathering trade tickets to be stored at the datacenter. As trading technology has advanced, so has the complexity of the trading records. Gone are the days of face-to-face transactions and handwritten tickets. These days the full history of a trade is likely to be spread across a variety of formats that could include electronic messenger, email and/or telephonic communication. Aggregating all of these different formats into one cohesive file, can be quite a daunting task.

Furthermore, the task becomes even more complicated for firms that trade more exotic investments. Investments such as complicated derivatives and CDOs are notoriously hard to price. The smaller the market and/or demand for an investment, the more complicated it is to price, which can cause pricing models to lack consistency. As a result, backend record-keeping and IT applications can become flawed. Large-scale examples of these inconsistencies are evidenced in the methodology flaws that were uncovered by the debt rating agencies Moody’s and S&P. Recalibrating the flaws in line with updated methodology caused dramatic shifts in pricing for the impacted securities.

As an added complication, financial firms are also responsible for finding a way to securely migrate this massive amount of information from the main headquarters of operation to the datacenter without any breach of private client information. Once the data is securely migrated, the files must be converted to a WORM file in order to prevent tampering.

For these reasons alone it is no surprise that many smaller firms are opting to outsource the record-keeping aspect of operations. Business continuity and regulatory practices demand a solid record-keeping plan, but the cost to maintain such a plan often becomes too much to sustain in house.

As financial markets continue to innovate and advance, there are a small population of vendors who make it their sole purpose to address the growing demands of regulatory systems and to provide assurance to those concerned about the degree of which their operations are complying.

Being one of the those aforementioned vendors who utilize technology to complete and maintain full compliance to rule 17a-3 and all of the SEC stipulations and statutes, Loffa Interactive Group is committed to providing the peace of mind that Broker/Dealers want without the convoluted ways of out-sourced back office operations.