Failure to Implement Compliance Program Spells SEC Liability for B/D
Compliance is critical for any organization. Investment advisers and broker-dealers are required, for example, to have effective, implement compliance procedures. Despite the benefits of constructing and maintaining an effective compliance system, ranging from enhancing the culture of the firm to aid in the prevention of liability, the Commission continues to discover firms were firms fail to properly implement a system. Its latest action in this regard involved not just the misuse of confidential information but also a risk of insider trading involving a registered broker-dealer. In the Matter of Mizuho Securities USA LLC, Adm. Proc. File No. 3-18609 (July 23, 2018).
Respondent Mizuho Securities is a registered broker-dealer that is an indirect, majority owned subsidiary of Mizuho Financial Group, Inc., a foreign private issuer whose shares are listed on the NYSE. The firm’s U.S. Desk was responsible for facilitating U.S. equity trades for its largely institutional customers. The International Desk accepted customer orders in securities traded on markets in Asia, routing them to affiliates. That desk was also responsible for handling corporate repurchases or buybacks of its securities.
The broker-dealer’s policies and procedures designated each of its business units as either “private side” or “public side.” The former meant that the unit had been designated by management and compliance as having access to material nonpublic information. The latter meant the unit had not received such a designation. Barriers were in place between the private and public sides. The U.S. Desk and the International Desk were both designated as public side.
During the two year period involved here beginning in 2012 Mizuho’s International Desk executed as many as fifteen issuer buybacks per day. Those transactions were typically executed in a manner that complied with Exchange Act rule 10(b)-18 which provides a safe-harbor from manipulation. Typically Mizuho executed buyback transactions before market open. The order information was entered into a management system that was linked to trading algorithms at two third party broker-dealers whose contracts contained confidentiality clauses.
Prior to market open the International Desk “routinely shared buyback order information with the U.S. Desk,” according to the Order. The head execution trader on the U.S. Desk frequently conveyed the information about the buybacks to the sales traders on the desks. Customers were also periodically told about the orders.
Communications of non-public, material, confidential information about buyback orders was routinely communicated despite the dictates of firm polices and procedures. The firm maintained a barrier between the U.S. and International Desks. Its policies and procedures required that confidential customer order information, including the identity of a customer placing an order, be protected as confidential. The firm’s training programs instructed that such information was confidential. The broker’s insider trading policy specifically included information about buybacks. Nevertheless, each day inside information was transmitted from the International Desk to the U.S. Desk where the details of the orders were shared with other traders and at times customers.
Exchange Act section 15(g) requires that registered broker-dealers establish, maintain and enforce written policies and procedures, reasonably designed in view of the firm’s business, to prevent the misuse of inside information. Here the firm failed to comply with the dictates of this rule by not properly implementing its systems. Indeed, the practice continued until after the Commission initiated its investigation. At that point Respondent halted the communication of buyback information and strengthened its procedures.
To resolve the proceedings, Respondent consented to the entry of a cease and desist order based on the section cited in the Order and to a censure. The firm will also pay a penalty of $1.25 million.