The global COVID-19 pandemic has changed the way many of us live, work, and invest. Trading activity in global and domestic markets spiked last year, partly as a result of the added time millions spent at home to avoid exposure to the coronavirus.
The Futures Industry Association (FIA) noted that global trading in futures and options increased 32% in the first half of 2020, compared to the same 6-month time frame the previous year. The surge in trading volume was more pronounced in U.S. markets, with options volume rising 50% in the first 11 months of the year measured against the same period in 2019.
In October 2020, options volumes in the U.S. set a monthly record with 583.7 million contracts traded—5.3 million contracts more than the previous monthly record set in March. Many broker-dealers reported 100% increases or more in equity trading volume year over year. The number of Initial Public Offerings (IPOs) last year increased by approximately 20%, no doubt bolstered by newly found investor enthusiasm.
The SEC’s ‘Large Traders Rule’
Compliance departments of financial advisory firms are familiar with requirements set by Section 13 of the Securities Exchange Act (SEA) of 1934. SEA Section 13 applies to persons who either own or exercise investment discretion over client accounts of publicly traded or exchange listed equity securities.
Most aspects of Section 13 apply to large firms which must file U.S. Securities and Exchange Commission (SEC) Schedule 13D or SEC Schedule 13G and SEC Form 13F. Schedule 13D is better known as a “beneficial ownership report” filed when a person or group acquires more than 5% of any class of a company’s equity shares. Schedule 13G is a shorter version that can be filed in lieu of Schedule 13D as long as the filing firm meets one or more of several exemptions.
SEC’s Form 13F must be filed quarterly by institutional investment managers with at least $100 million in assets under management. Form 13F filings are made to disclose the equity holdings of Registered Investment Advisers, mutual fund firms, hedge funds, and pension funds, among others.
Firms that don’t meet the necessary filing requirements for Schedule 13D, Schedule 13G, or Form 13F nevertheless may have the need to file SEC Form 13H within 45 days of the end of the previous calendar year. Form 13H is used for compliance of Rule 13h-1, commonly known as the “Large Traders Rule.” The SEC Office of Compliance Inspections and Examinations (OCIE) noted several recent instances of potential non-compliance of the rule by member firms in a Risk Alert posted December 16, 2020.
Who Must Comply
Rule 13h-1 defines a Large Trader as a person whose transactions in National Market Securities (NMS) equal or exceed 2 million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month. The Rule also applies to persons who exercise investment discretion over trading in NMS securities.
When a firm is just starting out, it’s not going to be a Large Trader by SEC definition. But when a firm grows to 1,000 to 1,500 clients, there’s a good chance -particularly if you’re running models – that you’re trading volume could increase enough to trigger the need for Form 13H.
One of the biggest ideas behind the Form 13H Risk Alert is to understand that this requirement exists, and that it should be a part of your annual review testing. You should make a periodic review and assessment to determine if you need to file it. A regular review of your trade logs is essential.
To comply with Rule 13h-1, broker-dealers must maintain records for all transactions “effected directly or indirectly by or through (i) an account such broker-dealer carries for a Large Trader or an Unidentified Large Trader or (ii) if the broker-dealer is a Large Trader, any proprietary or other account over which such broker-dealer exercises investment discretion.” The Rule also requires that upon request of the Commission, broker-dealers report certain Large Trader information using the Electronic Blue Sheets infrastructure.
Is Your Firm SEA Section 13 Compliant?
A leading best practice in achieving compliance with Rule 13h-1 is to review your firm’s policies and procedures as they apply to all of SEA Section 13. The sharp increase in market activity in 2020 shows no signs of abating in 2021, meaning more firms will qualify as Large Traders and need to adhere to Rule 13h-1.
Core Compliance & Legal Services has the knowledge and experience to help your firm comply with all aspects of SEA Section 13. To schedule a consultation, contact us at 619.278.0020 or email us at Info@corecls.com.