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News Alert: Mitigating Risks Associated with Master/Sub-Account Arrangements

On September 29, 2011, the SEC issued a Risk Alert warning of concerns regarding trading through sub-accounts, and offered suggestions to help the securities industry address those risks. Generally, in the master/sub-account trading model, a top-level customer[1] opens an account with a registered broker-dealer that permits the customer to have subordinate accounts for different trading activities. The master account usually will be subdivided into subunits for the use of individual traders or groups of traders. In some instances, these sub-accounts are further divided to such an extent that the master account customer and the registered broker-dealer may not know the actual identity of the underlying traders. Although these arrangements may be used for legitimate business purposes, this structure may expose both the customer and broker-dealer to significant risks or violations of securities laws. For example, the SEC has identified the following risks associated with master/sub-account trading model: money laundering, insider trading, market manipulation, account intrusions, unregistered broker-dealer activity, and excessive leverage. To mitigate these risks and to reduce the opportunity for violations of securities laws, consider utilizing the following controls with master/sub-account trading models:

  • Obtain and maintain the names of all traders authorized to trade in each master account, including all sub-account traders; verify the identities of all such traders, using fingerprints if appropriate, background checks and interviews; and periodically check the names of all such traders through criminal and other databases;
  • Monitor trading patterns in both the master account and sub-accounts for indications of insider trading, market manipulation, or other suspicious activity;
  • Physically secure information of customer or client systems and technology;
  • Regularly review the effectiveness of all controls and procedures around sub-account due diligence and monitoring; and
  • Create written descriptions of all controls and procedures for sub-account due diligence and monitoring, including the frequency of reviews, the identity of those responsible for conducting such reviews, and a description of the review process.

For additional information please contact Brent Cunningham, Associate by email at [email protected] or by phone at (619) 298-2880.

[1] In many instances, the customer opening the master account is a limited liability company, limited liability partnership or similar legal entity or another broker-dealer with numerous other persons trading through the master account.

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