| March 18
March 18 A proposal by Wall Street's
industry-funded watchdog to ramp up oversight of securities
brokerages could expose clearing firms to more enforcement
actions and lawsuits, lawyers say.
The Financial Industry Regulatory Authority has said it
wants to review, on a continuous basis, vast quantities of data
from the clearing firms that brokerages hire to settle
customers' buy and sell orders.
But some clearing firms are raising concerns that the
fledgling plan could ensnare them in legal hassles. As the data
flows from brokerages to FINRA, the clearing firms could be held
accountable for malfeasance buried in that information, they
say. For example, FINRA could question why a clearing firm did
not spot that a brokerage customer was laundering money.
"The clearing firm should not become another supervisor,"
said Ira Hammerman, general counsel for the Securities Industry
and Financial Markets Association, a trade group representing
clearing firms as well as retail brokerages. SIFMA plans to
voice its concerns in a letter this month.
Consumer investor lawyers agree that the proposed system
could make clearing firms bear more responsibility for errant
behavior. "For decades, clearing firms have buried their heads
in the sand, saying they don't have responsibilities for
anyone," said Andrew Stoltmann, a Chicago lawyer who represents
investors. "I think that defies common sense."
A FINRA spokesman declined to comment.
FINRA announced the plan, known as the Comprehensive
Automated Risk Data System, or CARDS, in December, but recently
extended the deadline for public input to March 21. The system
could take years to put in place, as FINRA would have to develop
a more formal proposal and get approval from the U.S. Securities
and Exchange Commission.
The watchdog is exploring the idea as financial regulators
try to expand their presence by mining data. The SEC, for
example, has recently announced efforts to crunch trading data
to detect insider trading and other illegal activity.
FINRA already receives some data from clearing firms for its
brokerage examinations, but they provide it voluntarily and
often upon request, the regulator has said. For example,
examiners may ask for data about trades in a certain security.
CARDS, however, would require clearing firms to be a
pipeline for an "unprecedented" combination of data, said Joan
Schwartz, chief legal officer of Bank of New York Mellon Corp's
Pershing LLC unit.
Clearing firms like Pershing would have to transmit an
ongoing stream of data to FINRA about everything from securities
transactions and asset movements to customers' risk tolerances
and time lines. At Pershing alone, those responsibilities would
apply to millions of brokerage accounts.
FINRA recently said it would not require clearing firms to
submit details, such as names and Social Security numbers, that
would identify specific brokerage customers.
Nor will FINRA hold clearing firms responsible for the
accuracy of the data, according to its plan, but that protection
is limited, said Irwin Pronin, a New York lawyer who advises
clearing firms. More risks could come later if the regulator
looks back and says a clearing firm turned a blind eye to
brokerage misbehavior revealed in its data, Pronin said.
Daniel Nathan, a Washington lawyer who advises brokerages on
regulatory issues, said the plan could make clearing firms
vulnerable to fines and other sanctions. The proposed system
"will have the effect of dumping into FINRA's lap a treasure
trove of potential evidence" that could show what a clearing
firm might have known about the brokerage firm's activities, he
To be sure, FINRA requires brokerages and clearing firms to
sign agreements that lay out which entities are liable for
certain responsibilities. For example, retail brokerages are
responsible for opening customers' accounts and recommending
securities that are in sync with their goals.
But even that may not be an ironclad defense. Pershing's
Schwartz, who is also vice chair of SIFMA's clearing firm
committee, pointed to a December enforcement case in which FINRA
described a clearing firm as a "gatekeeper to the securities
markets." The term could signal a change in regulators'
expectations for these firms, Schwartz said.
"We're generally concerned about the erosion of this concept
that we're 10 steps removed," Schwartz said.
FINRA's proposal follows a spate of lawsuits and securities
arbitration cases against clearing firms by investors.
Some cases were filed when an investor's brokerage goes out
of business, often because of a fraud. Others may involve
brokerages that cannot make good on losses in a risky security.
Pursuing the clearing firm may be the only way for investors to
recoup money, lawyers say.
These are tough cases to win, but investors have sometimes
prevailed. In 2010, creditors of Bayou Group LLC scored a $20.6
million arbitration award against a Goldman Sachs Group Inc
unit that cleared the hedge fund's trades. Bayou, which
was bankrupt, turned out to be a Ponzi scheme.
The case hinged on Goldman's ignoring data about the hedge
fund's losses, said Ross Intelisano, a New York lawyer who
represented the creditors.
Goldman lost two efforts to overturn the ruling. A Goldman
spokeswoman declined to comment.
In another case, a group of athletes filed a
multimillion-dollar arbitration against Pershing last year,
saying the clearing firm should have detected that private
investments their adviser recommended in a failed casino project
were fraudulent. The case is pending, and Pershing declined to
At least several arbitration cases against other clearing
firms were settled last year, according to a FINRA database.