Navigating Complex Trading Strategies Demands Surveillance Focus and Specialization


Industry, self-regulatory organizations (“SROs”), from the exchanges to FINRA, and federal regulatory bodies, including the SEC and CFTC, have become far more vigilant with surveillance, and proactive with seeking the associated fines, censures, and sanctions related to manipulative trading. Regulatory scrutiny has increased in line with more complicated, faster, and anonymous execution.

Lime Brokerage defines a variety of trading activities and how a broker dealer can efficiently and effectively utilize multiple surveillance tools to identify those possible manipulative practices. With detailed information in hand, it is imperative to work with clients to explain surveillance findings, engage their insights and input, and rectify any issues before the need for regulatory intervention.

There are multitudes of manipulative activities that regulators have focused on in recent years.

Spoofing is one such activity, which occurs when a trader enters orders that they do not intend to execute, versus a bona fide order on the opposing side of the market, in an effort to achieve a beneficial fill price or increase the likelihood of execution. Regulators have taken actions against a number of traders and brokerage firms recently with sizeable fines and even securing jail sentences and criminal charges. FINRA, CME, and the national regulators have recently broadened the scope of activity that could be considered fraudulent, by bringing charges for the very broadly defined “attempted spoof.”

Regulators, and in particular, FINRA, continue to develop surveillance software designed to identify instances of spoofing, attempted spoofing, and most recently, cross-market spoofing. Those who access the markets, or supply access to others, must be aware of the no tolerance approach and regulatory environment for any activity that is deemed to be disruptive. Brian Morris, Lime’s head of surveillance, states, “Spoofing can certainly keep surveillance and compliance officers up at night. Without proper surveillance software and an educated staff that is able to detect and distinguish differences between bona fide order entry and potentially manipulative activity, firms are exposing themselves to significant regulatory and reputational risk.”

In addition to spoofing, surveillance officers are also concerned with other activities that may be considered manipulative or disruptive by regulators. FINRA mentioned in its most recent annual report that marking the open and close, using layered prices to influence options pricing and manipulating ETFs, are all concerns of the industry’s self-regulator. Additionally, FINRA, BATS, NYSE, and Nasdaq have communicated a desire to initiate an expedited proceeding, in the event that a firm is facilitating orders that may be disruptive in nature; orders that are not necessarily detectable without a dedicated and vigorous surveillance program, process, and procedures.

To combat regulatory scrutiny and reputational risk, those accessing or offering access to the market must have a robust surveillance process. This process must be comprised of powerful market-monitoring software and dedicated personnel who understand how to navigate the difficult tasks of anticipating and understanding regulatory expectations. They must also be able to identify differences between manipulative and legitimate trading activity. In addition, open communication must be maintained with the clients, whose businesses range from point and click trading to sophisticated algorithmic execution models. Market-monitoring surveillance software choices are now plentiful as both industry software stalwarts and startups alike have recognized the need for robust programs that offer a comprehensive view of markets including depth of book, time and tick, and market replay functionality.

Dermot Harriss, Senior Vice President of Regulatory Solutions for One Market Data notes, “As regulators bring increasingly sophisticated surveillance tools to bear, they are penalizing traders for patterns of practice they couldn’t detect before. This raises the self-surveillance bar for all market participants. The ability to see the entire state of the market – from the time prior to order entry, to the time of order entry, to a trade, or order cancelation is irreplaceable to any surveillance officer looking to uncover instances of manipulative activity and mitigate damage to firm reputation or actions by regulators.“

Looking forward, should we expect that the Trump presidency will signal a sea change when it comes to financial regulation and enforcement? The early returns from FINRA, the SROs, and federal regulators have signaled that this outcome is not necessarily imminent and that vigilant enforcement of rules and regulations will continue. Moreover, any decrease in regulatory funding could possibly be offset by higher transactions fees and fines from settlements and judgments. The takeaway is straightforward- firms serious about their reputation and profitability are wise to invest in a strong, robust, market monitoring surveillance program.

Written by Brian Morris, Compliance Officer – Surveillance of Lime Brokerage, LLC

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