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From Securities Regulation Daily, November 19, 2014

Commission unanimously approves Regulation SCI

By Jacquelyn Lumb

The Commission today unanimously approved the adoption of Regulation Systems Compliance and Integrity, known as Regulation SCI, to strengthen the technological infrastructure of the U.S. securities markets. SEC Chair Mary Jo White said that today’s actions mark an historic shift in the SEC’s regulation of the functions of the securities markets. Regulation SCI has a significant reach beyond the voluntary program it replaces, the Automation Review Policy, which relied on voluntary participation by the self-regulatory organizations.

SCI entities. Regulation SCI will require all self-regulatory organizations, including national securities exchanges, registered clearing agencies, FINRA, the MSRB, significant alternative trading systems, processors of consolidated market data, and certain exempt clearing agencies, to adopt policies and procedures to ensure that their systems have adequate capacity, integrity, resiliency, and security.

SCI entities must take prompt corrective action in response to any systems disruptions, compliance issues, or intrusions. These entities must electronically file new Form SCI to report any material systems changes. They also must notify members or participants of any significant systems problems.

Compliance reviews. Regulation SCI requires annual compliance reviews, with the reports going to senior management, the board of directors, and the SEC. SCI entities must annually test their business continuity and disaster recovery plans, and coordinate with other entities on an industry-wide or sector-wide basis. Regulation SCI also imposes new recordkeeping requirements.

Guidance. White noted that there are no widely used industry or government standards to address the systems used by the SCI entities today, so the SEC will issue guidance on the existing standards that could serve as a foundation for the development of a uniform set of SCI standards. She said it would not be responsible to delay the SEC’s adoption of Regulation SCI while awaiting the development of uniformly high technical standards.

Potential expansion. White also has directed the staff to prepare recommendations for the possible expansion of the Regulation SCI framework to other key market participants, such as broker-dealers and transfer agents. It is critical to address any regulatory gaps with respect to market participants whose systems may have a significant impact if they are subject to disruptions or intrusions, she said.

Commissioner Luis Aguilar. Commissioner Luis Aguilar said the rules adopted today were a clear improvement over the initial proposal which, in his view, would have failed to adequately protect critical infrastructure. The proposal was modified to remove a safe harbor for SCI entities and to provide a safe harbor for SCI personnel who discharge their duties in a reasonable manner. Aguilar said the original proposal required no personal accountability, but under the final rules, senior management has responsibility for the systems subject to Regulation SCI.

Aguilar also believes it is critical to extend the rules to broker-dealers that operate proprietary trading systems and algorithms given their role in the May 2010 flash crash and other significant market disruptions.

Commissioner Daniel Gallagher. Commissioner Daniel Gallagher said the final rule is more prescriptive than he would have preferred, but he was pleased with the safe harbor for individuals since it will provide an incentive for SCI personnel to take a proactive role to address problems.

Commissioner Kara Stein. Commissioner Kara Stein saw the adoption of Regulation SCI as an initial step, but said the rules should be expanded to the many important trading centers that were left out. All firms with direct access to the markets should be part of the solution, in her view, and she said White’s initiative to consider expanding the framework to these entities is encouraging.

Commissioner Michael Piwowar. Commissioner Michael Piwowar commended the staff for addressing the highly critical comments about the original proposal. The final rules have been tailored and calibrated in response, he said, and they are designed to remain relevant as technology continues to develop. Piwowar said he was also pleased that the staff plans to update the guidance as new industry standards develop.

Compliance dates. The rules will become effective 60 days after publication in the Federal Register. SCI entities must comply with Regulation SCI nine months after the effective date, except for ATSs that meet the threshold for the definition of an SCI ATS for the first time, which will be given an additional six months to comply. SCI entities will have an additional 21 months after the effective date to comply with the industry or sector-wide coordinated testing requirement.

The release is No. 34-73639.

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