The Securities and Exchange Commission's Office of Compliance Inspections and Examinations has released new guidance to help firms prevent and detect unauthorized trading in brokerage and advisory accounts.

The guidance stated that, although broker-dealers and investment advisers are subject to different regulatory requirements, both face similar risks of financial and reputational losses arising from unauthorized trading.

“Unauthorized trading is not a new problem, and the risks it poses should be a perennial concern to financial firms as well as to regulators,” said OCIE Director Carlo di Florio. “We hope that the observations shared in the Risk Alert will be helpful for firms as they review their compliance and supervisory controls to detect and deter unauthorized trading.”

The guidance uses the term “unauthorized trading” to define a broad range of activities, including:

“Rogue” or other unauthorized trading or trade execution in customer or client or proprietary accounts;

Exceeding firm limits on position exposures, risk tolerances, and losses;

 Intentional mismarking of positions; and

Creating records of nonexistent (or sham) transactions.

Unauthorized trading can be done by traders, assistants on trading desks, portfolio managers, brokers, risk managers, or other personnel, including those in administrative positions in a firm's back office.

The OCIE notes that changes in trading patterns, a high volume of trade cancellations or corrections, manual trade adjustments, or unexplained profits for a particular trader or client may warrant additional scrutiny.

One critical element in mitigating the risks posed by unauthorized trading is to have independent and mutually reinforcing controls. In this aspect, the guidance recommends that operational risk, audit, legal, and compliance functions work closely with management in performing an independent identification of risks and practices that could permit unauthorized trading.

Reviewing or testing internal controls on a regular basis may also be necessary, as well as assessing their adequacy to prevent unauthorized trading in light of internal business changes and current market conditions, among other factors.

Additionally, the OCIE says management and non-management employees should be appropriately trained to identify unauthorized activity. Firms also should carefully consider how best to facilitate proper and immediate escalation of any detected activity without fear of retaliation.

The alert recommends compliance measures that firms may want to adopt to protect themselves and their clients from unauthorized trading, such as stress testing and independent trading reviews.

It also mentions policies that require traders to take vacations without remote access to trading accounts. These policies could be enhanced, for instance, by using the trader's vacation to conduct a special review of the trader's portfolio for signs of unusual activity.

The alert is the second this year and the fourth in a continuing series of Risk Alerts that the SEC's examination staff expects to issue.