FINRA issued the final podcast in its six-part series on Regulatory and Examination Priorities for 2015. The sixth podcast focuses on market integrity and addresses the following priorities:
Supervision and Governance Surrounding Trading Technology
- FINRA stated that it is reviewing (i) firms’ technology and related controls with an emphasis on “the development and ongoing supervision of algorithms,” (ii) the segregation of duties among technology staff, (iii) firms’ risk management, as well as their financial and operational controls, and (iv) the intraday monitoring of net capital.
- FINRA stressed that it “views these algorithms and failures to supervise for potential manipulation to be one of the biggest risks to market integrity,” and stated that it continues to pursue firms whose traders or customers use algorithms to manipulate markets.
Cross-Market and Cross-Product Manipulation
- FINRA reported that its cross-market surveillance covers 99% of the U.S. equities markets, and emphasized that it provides surveillance services to “about two-thirds of the options market.”
Order-Routing Practices, Best Execution and Disclosure
- FINRA stated that it is reviewing “firms that route much of their unmarketable customer limit orders to trading venues that provide the highest trading rebates for providing liquidity” and, as a consequence, the “routing decisions for marketable versus non-marketable orders to see how rebates impact those decisions.”
- FINRA stated that its “examiners are looking for firms that are intermediating transactions on structured products, but have not adequately disclosed to their customers how they would be charged.”
Market Access Controls
- FINRA stated that it has “noticed confusion about how the [SEC market-access] rule applies to fixed-income markets.”
- In response to the control challenges faced by firms, FINRA announced, it is “starting a PILOT program to give firms relationship trading alert activity detected in its cross-market surveillance program,” which can be used by the firms “to supplement their ability to detect and prevent manipulative activity through multiple firms.”
- FINRA stated that it continues to focus on late reporting on TRACE-eligible and municipal securities that “affect FINRA’s audit trail.”
- FINRA announced that it has formed a new team “to focus on finding potential equity audit-trail issues not usually detected through routine sweeps and reviews.”
FINRA also announced that it is launching a pilot program to examine trading issues and controls for fixed-income securities in 2015. According to FINRA, this fixed-income program will focus on areas that complement FINRA’s surveillance program, such as alternative trading systems, books and records, and supervision.
Lofchie Comment: From a compliance risk standpoint, two areas stand out: (i) order routing and rebates, and (ii) compliance/supervisory procedures around the development/maintenance/testing of trading algorithms.