As a broker-dealer, you rely on a network of third-party vendors to deliver services efficiently and stay competitive. These partnerships bring efficiency and innovation, but also introduce compliance and regulatory risk.
Regulators like FINRA and the SEC expect broker-dealers to manage not only their internal compliance, but also the compliance of the third parties they rely on. That means you’re responsible not only for your firm’s compliance, but also for the vendors you rely on when they are acting on your behalf.
If a vendor fails to meet regulatory expectations, your firm could bear the consequences, including cyber breaches, operational disruptions in addition to fines, enforcement actions, and reputational harm.
That’s why activities like due diligence, contract oversight, and ongoing monitoring are essential. They help ensure your vendors are aligned with regulatory standards and protecting your firm’s interests. Here’s what you need to know about managing third-party compliance risk and how to do it effectively.
What is Third-Party Compliance Risk for Broker-Dealers?
Third-party compliance risk is the risk that a third party might fail to meet regulatory requirements or adhere to your firm's internal policies. Broker-dealers need to consider if the third party accesses sensitive information or provides a product or service that exposes your firm to regulations.
If a third-party vendor fails to follow the rules, the consequences fall on your firm.
Examples of Third-Party Compliance Risk for Broker-Dealers
Third-party relationships can open the door to serious compliance exposure, even when your firm isn’t the one making the misstep. From cybersecurity gaps to supervision failures, here are common scenarios where vendor risk becomes your risk.
- Cybersecurity breach at a tech vendor - A cloud service provider housing client account data suffers a data breach. Even if your firm wasn’t the direct target, you’re still responsible for ensuring the vendor had appropriate controls in place — and may face regulatory scrutiny under SEC and FINRA guidelines. Plus, your firm must comply with state and federal notification requirements and privacy laws.
Related: Common Vendor Data Breaches and Trips to Prevent Them
- Inadequate supervision by an outsourced call center – A third-party call center provides customer support but fails to follow required disclosures or misrepresents product information. Your firm may be held accountable for failure to supervise third-party communications.
- Improper data handling by a marketing vendor – A digital marketing vendor collects client contact information but stores it improperly, violating regulation S-P. Your firm faces reputational risk and potential enforcement action for failing to ensure proper privacy protections.
- Third-party trade processor fails AML checks – A vendor that processes trades on your behalf fails to screen transactions for potential money laundering. Regulatory agencies may hold your firm responsible for gaps in anti-money laundering (AML) compliance, especially under the bank secrecy act.
- Outdated compliance certifications – A vendor providing compliance software or tools allows certifications or control attestations (e.g., SOC 2) to lapse without your knowledge. Relying on outdated information may expose your firm to operational and compliance risk.
- Third-party business continuity failure – A vendor critical to trading operations experiences a service outage but lacks an effective business continuity plan (BCP). Your firm’s operations are disrupted and regulators question your due diligence and oversight.
Related: Vendor BCP: What Broker-Dealers Need to Know
How Broker-Dealers Can Manage Third-Party Compliance Risk
Managing third-party compliance risk is critical to protecting broker-dealers' operations and customers, while also maintaining regulatory compliance.
FINRA’s Regulatory Notice 21-29 outlines expectations for broker-dealers to oversee third-party activities and ensure compliance. The SEC’s Regulation S-P also requires third-party oversight activities, like due diligence and monitoring.
Related: Inside the SEC’s New Vendor Management Requirements
Here are seven practical steps to help broker-dealers manage third-party compliance risk, even if you’re just getting started:
- Know your third parties – Start with a complete inventory of third parties. List who your vendors are, what services they provide, and whether they access sensitive data or perform functions tied to compliance. Risk assessments at onboarding help flag which vendors carry more regulatory risk.
- Follow a risk-based strategy – Not every vendor poses the same risk. Focus more time and attention on higher-risk vendors — those with access to sensitive systems, customer data, or involved in regulated activities.
- Conduct thorough due diligence – Look under the hood before signing on. Review vendor policies, security certifications (like SOC 2), prior regulatory issues, and how they train staff on compliance. Make sure they have the controls needed to protect your firm.
Related: Due Diligence Checklist for Low, Moderate, and High-Risk Vendors
- Understand residual risk – Even good vendors have gaps. After due diligence, assess what risk still remains (residual risk) and decide if your firm can accept it. If the remaining risk is too high, walk away.
- Set clear contractual expectations – Contracts are your first line of defense. Include third-party contract clauses that:
- Require vendors to follow relevant laws and regulations
- Give you the right to audit them
- Outline how they’ll handle data and breach notifications
- Allow you to terminate the relationship for noncompliance
- Continuously monitor vendor risk – Risk changes over time. Review vendor performance and documentation regularly, track any red flags, and consider using tools that give you real-time insight into vendor risks.
Related: Key Performance Indicators in Vendor Risk Management
- Track and resolve compliance issues – If a vendor issue arises, act fast. Document the problem, work with the vendor on a fix, and follow through until it’s resolved. Keep records to show regulators you took appropriate steps.
Third-party compliance risk is a regulatory concern, but it’s also a business risk. A single vendor misstep can lead to data breaches, service disruptions, regulatory investigations, and lost client trust. In today’s environment, that’s not hypothetical — it’s happening.
Broker-dealers that actively manage third-party relationships are better positioned to spot issues early, respond quickly, and protect what matters most: client data, firm reputation, and operational stability.
Want an overview of vendor risk management? Watch our on-demand webinar: Vendor Risk Management 101.