In keeping with its prior year practice, on January 11, 2013, FINRA (the “Agnecy”) issued a Examination Priorities Letter to member firms highlighting the areas of the industry it intends to focus particular attention and resources. These areas include market regulation, business conduct, insider trading, financial and operational concerns.
Market Regulation
As computer based trading continues to capture an increasingly large segment of the market, the Agency has identified algorithmic, high frequency and alternative trading as areas of particular concern to individual investors and the integrity of the market as a whole.
- Algorithmic Trading. Algorithmic trading is the practice of implementing pre-programmed computer systems or models to trade without human involvement. The agency is concerned that members’ implement rigorous testing systems prior and during the use of these programs to avoid malfunction and potential domino effects on the market as seen during the “flash crash of 2010.
- HFT. While high frequency trading systems provide liquidity to the market and are not necessarily more manipulative than other strategies, due to their opaque nature, they may embody abusive trading practices that are difficult or market participants to discern. Particular attention therefore needs to be paid to the potential abusive effect of HFT strategies prior and during their implementation.
- ATS. Alternative Trading Systems are platforms that match buyers and sellers outside of traditional regulated exchanges allowing large volume buyers and sellers to be matched without market volume and price to be directly impacted.
Business Conduct and Sales Practices
- Cyber-Security. As cyber attacks have become a constant threat to the securities industry, FINRA has focused its efforts to monitor member firm’s information securities policies and procedures to ensure confidential client information is protected. The agency has indicated that it will monitor member firms’ information security and customer data controls through systematic examinations and targeted investigations.
- Private Placements. The Agency’s recent implementation of Rule 5123, which requires member firms that sell an issuer’s securities in a private placement to individuals to file a copy of the issuer’s private placement memorandum, will provide the agency with the information it needs to better implement its risk based monitoring regime and identify higher risk transactions. FINRA also reiterated the need of member firms to perform reasonable due diligence on prospective issuers with a particular focus on their creditworthiness, validity and integrity of their business model and plausibility of expected rates of return.
- Insider Trading. FINRA, the SEC and federal criminal law enforcement officials remain intent on cracking down on trades made pursuant to material non-public information. As a result, the Agency expects member firms to vigilantly protect such information by conducting periodic assessments of information barriers and risk controls.
Conclusion
While the Agency will not ignore other aspects of member firm’s duties, aspects of the industry identified in the Letter will remain fertile ground for Agency inquiries in the coming year, and beyond, and member firms are well advised to review their policies and procedures to ensure that they comply with FINRA rules.
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