Disruptive Quoting and Trading Activity
In December 2016, FINRA implemented two new rule changes regarding disruptive quoting and trading activity. The first rule change adopts new Supplementary Material .03 to Rule 5210 (Publication of Transactions and Quotations) to explicitly define and specifically prohibit for purposes of Rule 5210 two types of quoting and trading activity that are deemed to be disruptive. The first type of activity involves a party entering multiple limit orders on one side of the market that changes the level of supply and demand for the security, entering one or more orders on the opposite side of the market that are subsequently executed, and, following the execution, canceling the original limit orders. The second type of activity consists of a party placing an order inside the national best bid and offer, and then submitting an order on the opposite side of the market to execute against another market participant that joined the new inside market.
The second rule change amends the FINRA procedural rules regarding temporary cease and desist orders (TCDOs), found in the Rule 9800 Series, to create a process for FINRA to issue, on an expedited basis, a permanent cease and desist order against a respondent that engages in a frequent pattern or practice of the disruptive quoting and trading activity in Supplementary Material .03 to Rule 5210.
• FINRA Regulatory Notice 17-22 (June 2017): FINRA Adopts Rules on Disruptive Quoting and Trading Activity and Expedited Proceedings
Best Execution Rule
In light of the increasingly automated market for equity securities and standardized options, and recent advances in trading technology and communications in the fixed income markets, FINRA reiterates the best execution obligations that apply when firms receive, handle, route or execute customer orders in equities, options and fixed income securities. FINRA reminds firms of their obligations, as previously articulated by the SEC and FINRA, to regularly and rigorously examine execution quality likely to be obtained from the different markets trading a security.
• FINRA Regulatory Notice 15-46 (November 2015): Guidance on Best Execution Obligations in Equity, Options and Fixed Income Markets
Limit Up/Limit Down Plan Program
On May 31, 2012, the SEC approved the NMS Plan to Address Extraordinary Market Volatility (Plan), which was filed by FINRA and the other SROs and is designed to address the type of sudden price movements that the market experienced on the afternoon of May 6, 2010. The Plan provides for a market-wide limit up and limit down (LULD) mechanism to prevent trades in NMS stocks from occurring outside of specified price bands, coupled with trading pauses to accommodate more fundamental price moves. The Plan is designed, among other things, to protect investors and promote fair and orderly markets.
• FINRA Regulatory Notice 16-26 (July 2016): FINRA Adopts Amendments Relating to the Regulation NMS Plans to Address Extraordinary Market Volitality
The Participants filed the Plan to Address Extraordinary Market Volatility (the “Limit Up-Limit Down Plan” or the “Plan”) with the Commission on April 5, 2011 to create a market-wide limit up-limit down mechanism intended to address extraordinary market volatility in NMS Stocks, as defined in Rule 600(b)(47) of Regulation NMS under the Exchange Act. The Plan sets forth procedures that provide for market-wide limit up-limit down requirements to prevent trades in individual NMS Stocks from occurring outside of the specified Price Bands. These limit up-limit down requirements are coupled with Trading Pauses, as defined in Section I(Y) of the Plan, to accommodate more fundamental price moves. In particular, the Participants adopted this Plan to address extraordinary volatility in the securities markets, i.e., significant fluctuations in individual securities’ prices over a short period of time, such as those experienced during the “Flash Crash” on the afternoon of May 6, 2010. The Plan was originally approved on a pilot basis to allow the public, the Participants, and the Commission to assess the operation of the Plan and whether the Plan should be modified prior to consideration of approval on a permanent basis. The Commission recently approved an amendment to the Plan to allow the Plan to operate on a permanent basis.
• Securities Exchange Act Release No. 85723 (April 25, 2019), 84 FR 18618 (May 1, 2019) (File No. SR-NYSENAT-2019-10): Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Amend Rule 7.11, Limit Up-Limit Down Plan and Trading Pauses in Individual Securities Due to Extraordinary Market Volatility
(New) Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds
The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), SEC, and Commodity Futures Trading Commission (CFTC) are adopting amendments to the regulations implementing section 13 of the Bank Holding Company Act (BHCA Act). Section 13 contains certain restrictions on the ability of a banking entity and nonbank financial company supervised by the Board to engage in proprietary trading and have certain interests in, or relationships with, a hedge fund or private equity fund. These final amendments are intended to provide banking entities with clarity about what activities are prohibited and to improve supervision and implementation of section 13.
• Securities and Exchange Commission Release No. BHCA-7 (September 18, 2019), 84 FR 61974 (November 14, 2019) (File No. S7-14-18; Final Rule): Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds
ATS Supervision Obligations
FINRA is issuing this Notice to remind Alternative Trading Systems (ATSs) of their supervision obligations. As registered broker-dealers and FINRA members, ATSs—like other broker-dealer trading platforms—are required to maintain supervisory systems that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules, including, for example, rules on disruptive or manipulative quoting and trading activity.
• FINRA Regulatory Notice 18-25 (August 13, 2018): FINRA Reminds Alternative Trading Systems of Their Obligations to Supervise Activity on Their Platforms
Cross Market Equities Supervision: Potential Manipulation Report
This report assists firms with monitoring their supervision for trading behaviors that may be designed to manipulate the market by displaying exceptions around two behaviors—layering and spoofing—concerns highlighted in FINRA’s 2016 Regulatory Examination Priorities Letter.
Equity Trading Initiatives: Supervision and Control Practices for Algorithmic Trading Strategies
As algorithmic trading strategies, including high frequency trading strategies, have grown to compose a substantial portion of activity on U.S. securities markets, the potential for these strategies to adversely impact market and firm stability has likewise grown. Although a reasonable supervision and control program may not foresee every potential failure or prevent every undesirable consequence, in an effort to reduce the future occurrence of such potential issues, FINRA is providing guidance on effective supervision and control practices for member firms and market participants that use algorithmic strategies. These effective practices are focused on five general areas: General Risk Assessment and Response; Software/Code Development and Implementation; Software Testing and System Validation; Trading Systems; and Compliance.
• FINRA Regulatory Notice 15-09 (March 2015): Guidance on Effective Supervision and Control Practices for Firms Engaging in Algorithmic Trading Strategies
FINRA Rule 3110 (Supervision) includes a provision to help firms comply with their obligation under Section 15(g) of the Securities Exchange Act of 1934 to have policies and procedures in place reasonably designed to prevent potential insider trading. Rule 3110(d) requires that firms include in their supervisory procedures a process for reviewing securities transactions in certain types of accounts that is reasonably designed to identify trades that may violate insider trading prohibitions. When implementing these policies and procedures, firms may take a risk-based approach to monitoring transactions that takes into account their specific business models, and firms are encouraged to tailor their policies and procedures to their specific business models.
• FINRA Regulatory Notice 14-10 (March 2014): SEC Approves New Supervision Rules