FINRA Resolutions: Market Integrity

By Patricia Uceda, Spring 2015 Graduate Research Assistant

Today in our final blog post in the FINRA Resolutions series, we will be discussing market integrity matters that FINRA plans on focusing on in 2015. As you may recall, FINRA has resolved to focus on several areas in order to better serve public investors, including key sales practice, financial and operational, and market integrity matters. We’ve already spoken to you about their key sales practice areas of focus and their financial and operational priorities. Here are some of the market integrity matters that will be receiving special attention from FINRA in 2015:

  • Supervision and Governance Surrounding Trading Technology: FINRA has identified a number of concerns in the electronic trading area, such as the algorithms used by firms for entering trading orders. They view abusive trading algorithms as one of the most significant risks to market integrity, and plan on reviewing firms’ supervisory controls in place for the development and testing of these technology changes. In addition, they will review firms’ risk management controls because the speed in which orders are completed in the market can introduce substantial risk.
  • Cross-Market and Cross-Product Manipulation: Due to the fact that fragmented markets can provide prime opportunities for scammers to disguise misconduct by trading in multiple markets, in 2015 FINRA plans on continuing to enhance its cross-market surveillance methods. Currently they cover over 99% of U.S. equity markets, although they have added new markets recently and hope to continue expanding.
  • Order Routing Practices: FINRA is the process of reviewing routing decisions for marketable versus non-marketable orders to ensure firms are not being improperly influenced. Recently, firms have been a large percentage of their unmarketable customer limit orders to trading venues that provide trade-fee rebates. FINRA is concerned that this could be a conflict of interest for firms that may receive inferior executions of their customers’ unmarketable limit orders while simultaneously collecting a trading rebate. Firms are encouraged to have active best execution committees in order to evaluate the quality of customer order evaluations.
  • Market Access: Four years ago the SEC adopted a Market Access Rule (Rule 15c3-5) which requires that risk management controls and supervisory procedures be reasonably designed to limit the financial exposure of the broker-dealer that could arise as a result of market access. However, since then FINRA has continued to find examples of inadequate market access controls relating to manipulation and erroneous quotes. In 2015, FINRA plans to provide firms with information to supplement firms’ supervision efforts with respect to detecting and preventing manipulative trading activity.
  • Audit Trail Integrity: FINRA will continue to focus on late reporting resulting from inadequate processes and procedures on trading desks. Many times firms will report larger-sized trades up to several hours late, which can negatively affect FINRA’s audit trail and its ability to assess whether a firm was at risk when executing a trade. FINRA plans to focus on this in 2015 by creating a new team to focus on identifying potential equity audit rail issues.