Series 99 Operational Risk & Controls 3 — Questions and Answers
Question 1: Under SEC Rule 17a-3, a broker-dealer is required to maintain which of the following records?
- Only trade confirmations for institutional clients
- Blotters, ledgers, order tickets, and customer account records (Correct answer)
- Solely records of foreign currency transactions
- Internal audit reports filed with the SEC
Correct answer: Blotters, ledgers, order tickets, and customer account records
SEC Rule 17a-3 requires broker-dealers to create and maintain specific records including blotters, ledgers, memoranda of orders, and customer account information.
Question 2: Which operational risk scenario represents a 'vendor or third-party risk'?
- A trader placing an order in the wrong security
- A clearing firm's technology outage delaying settlement for a correspondent broker-dealer (Correct answer)
- A compliance officer failing to file a SAR
- A customer disputing a trade confirmation
Correct answer: A clearing firm's technology outage delaying settlement for a correspondent broker-dealer
Vendor risk arises when a third-party service provider's failure disrupts the firm's operations, such as a clearing firm outage affecting correspondents.
Question 3: The Basel II/III operational risk framework defines operational risk as losses resulting from which of the following?
- Adverse interest rate movements
- Inadequate or failed internal processes, people, systems, or external events (Correct answer)
- Customer credit defaults on margin loans
- Unfavorable foreign exchange fluctuations
Correct answer: Inadequate or failed internal processes, people, systems, or external events
The Basel Committee defines operational risk as the risk of loss from inadequate or failed internal processes, people, systems, or external events, excluding strategic and reputational risk.
Question 4: A broker-dealer experiences a fat-finger trade error where a trader entered 1,000,000 shares instead of 10,000. Which control would MOST directly prevent this type of error?
- Daily position reconciliation
- Pre-trade order size limits and validation checks (Correct answer)
- Post-trade confirmation matching
- End-of-day supervisory review
Correct answer: Pre-trade order size limits and validation checks
Pre-trade controls such as order size limits and validation checks prevent erroneous orders from reaching the market before execution.
Question 5: SEC Rule 17a-4 primarily governs:
- The calculation of net capital requirements
- The preservation and retention period for required books and records (Correct answer)
- Reporting of suspicious activity to FinCEN
- The registration of broker-dealer personnel
Correct answer: The preservation and retention period for required books and records
SEC Rule 17a-4 specifies the retention periods and storage requirements for the records that broker-dealers are required to create under Rule 17a-3.
Question 6: An operations manager notices that fail rates on corporate bond settlements have increased from 2% to 15% over 30 days. This trend MOST likely indicates:
- Improved operational efficiency in the back office
- An emerging operational risk that requires investigation and remediation (Correct answer)
- Normal seasonal variation in settlement activity
- A regulatory requirement to increase settlement failures
Correct answer: An emerging operational risk that requires investigation and remediation
A significant spike in settlement fail rates is a key risk indicator signaling a potential operational problem that requires immediate investigation.
Question 7: Which of the following BEST describes the purpose of an internal audit function within a broker-dealer's operational risk framework?
- To execute trades on behalf of the firm's proprietary desk
- To independently assess the effectiveness of internal controls and risk management processes (Correct answer)
- To set commission rates charged to retail customers
- To approve all new product launches
Correct answer: To independently assess the effectiveness of internal controls and risk management processes
Internal audit provides independent and objective assurance that the firm's controls, governance, and risk management processes are adequate and functioning effectively.
Series 99 Operational Risk & Controls 3
Under SEC Rule 17a-3, a broker-dealer is required to maintain which of the following records?