This Is Why Proprietary Trading Firms Should Be Registered With FINRA


The SEC has just published their 133 page proposal for rule amendments to Rule 15b9-1 , which would require stricter registration requirements for some proprietary trading firms, and we are already seeing the HFT lobby working the media to defeat this proposal.   This  Bloomberg piece  “New HFT Oversight Viewed As Hollow Victory For U.S. Regulators” ​quotes one of the founding members of the Modern Markets Initiative as saying:

“The firms, however, are already effectively scrutinized by Finra because they’re members of exchanges such as the New York Stock Exchange and the Nasdaq Stock Market that outsource much of their regulatory duties to the organization, said Adam Nunes, head of business development at Hudson River Trading, a high-frequency trading firm. Finra examiners, for example, already visit the firms and inspect trading logs.   “This sounds good, but little is changing with respect to our regulatory interactions,” Nunes said. “Finra already performs this function on behalf of most exchanges.”

Apparently, Mr. Nunes and Hudson River Trading feel that being a member of an exchange has the same regulatory obligations as being a member of FINRA.  Why then have other proprietary trading firms like Allston and DRW continued to lobby against FINRA registration?   Maybe we can get a hint from what Rick Ketchum, the Chairman and CEO of FINRA, said in a speech last year:

This is powerful stuff—because there are market participants out there who are actively dispersing their trading activity across markets in an attempt to avoid detection. With our cross-market surveillance program, we can run dozens of surveillance patterns and threat scenarios across our mountain of data to look for, among other things, layering, spoofing, algo gaming, wash sales and other manipulative and distortive conduct. 

Because of the sophistication of these patterns, we are detecting things that we had not been able to see before: over 80 percent of our cross market alerts involve conduct occurring on more than one market and over 50 percent of our cross market alerts involve two or more market participants.”

FINRA’s surveillance methods have gotten much more sophisticated and are now reaching across equity and options exchanges.  While they don’t have the ability to reach across other asset classes like futures and currencies, they are viewing our fragmented equities and options markets much more clearly now.  FINRA’s equity and options cross-market surveillance program is proving to be very successful at uncovering possible manipulative activity and according to Rick Ketchum, FINRA has more than 170 investigations open concerning abusive algorithms, inadequate supervision of algorithms and deficient order controls.”

In their proposal, the SEC clearly states why they think proprietary trading firms should be registered with FINRA and not just with individual SRO’s:

“FINRA currently conducts cross-market surveillance and is provided exchange audit trail data pursuant to existing RSAs and 17d-2 agreements.  In contrast, exchanges generally do not conduct cross-market surveillance and most have allocated this responsibility to FINRA. Accordingly, the Commission believes that, as a practical matter and consistent with Section 15(b)(8), FINRA is currently in the best position to regulate cross-market activity by broker-dealers that effect transactions on exchanges other ​than those of which the broker-dealer is a member, even if they do not effect transactions in the off-exchange market.”

Most trading is now conducted across highly fragmented stock and options exchanges and regulators need the ability to see across these markets.  The SEC’s rule amendments to Rule 15b9-1 will shine more light on these fragmented markets.