SEC Warns About Misuse of Master Sub-Account Model

September 30, 2011

The Securities and Exchange Commission's  ("SEC's") Office of Compliance Inspections and Examinations just posted its first issue of the "National Exam Risk Alert." In this inaugural edition, the SEC warns about the dangers of master/sub-account arrangements.  Among the misuses of sub-accounts noted by the SEC, are

  • money laundering,
  • insider trading,
  • market manipulation,
  • account intrusions,
  • information security,
  • unregistered broker-dealer activity, and
  • excessive leverage

Although the federal regulator concedes that master/sub-accounts can be used for legitimate business purposes, the gist of the Alert is to note abusive practices facilitated by this structure. In highlighting the risks to  broker-dealers offering master/sub-account trading models to customers, the SEC suggests a number of controls and procedures that would constitute better practices in terms of risk management and supervision. 

SIDE BAR: The typical set-up for a master/sub-account trading model involves an initiating customer (often a limited liability entity), who opens the Master Account.  Thereafter, the accommodating broker-dealer will establish a number of requested sub-accounts, typically earmarked for specific trading strategies and/or specific traders.  Master Accounts opened by Eastern European clients or for use in Day- or High-Frequency-Trading have been cited in several regulatory and criminal investigations.

Bill Singer's Comment

Given the relatively high-profile nature of this Alert,  it's likely that the SEC is preparing to announce a number of high-profile cases against entities and individuals involved with the improper use of Master/Sub-Accounts.  It would be unusual for the SEC to highlight these practices, particularly through the launch of a new online bulletin, without also having an ulterior motive - namely, to set the stage for a regulatory sweep or joint-task-force cases.  We'll have to see what the near future brings, but I"m guessing that something's up here.