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FLASHBACK FRIDAY: Finra Advises on Rogue Trading
Traders Magazine Online News, June 28, 2019
Take that vacation!
Back in June 2008 Finra recommended via a memorandum that taking time off was a leading way to detect and prevent rogue trading. Traders, FINRA said, should be required to take 10 consecutive trading days of vacation time so any unauthorized trades they might have made can be detected.
Two weeks.
Two consecutive weeks of vacation is nowadays considered to be awarded or allotted for special occasions – such as a honeymoon or birth of a child. But back then, the agency was in a pickle to try and stem rogue trading and sidelining a trader was actually considered so regulators could manually review his trading activity.
The suggestion came after a $7 billion loss at Societe Generale when junior trader Jerome Kerviel gambled without permission on index futures.
Fast forward to the present and forcing traders to take two weeks of vacation is off the table – with both firms and people resisting the move. Instead, the industry has come up with something a bit different – Regulation Best Interest and the Consolidated Audit Trail (CAT).
First, the latter. The CAT project has been well documented in the media, including here on Traders Magazine. The goal is to create an electronic trade trail where the regulators can easily and more quickly uncover nefarious trading activity. Jolted into creation by the June 1010 ‘flash crash,’ the CAT has yet to become fully operational. And as of this writing, Finra does track trade activity but on a two week lagging basis.
Regulation Best Interest (Reg BI) takes a 10,000 foot view of the trading business by requiring traders and their firms to act in the ‘best interest’ of clients. Reg BI was originally proposed back in April 2018 and was geared to require brokers to disclose to clients all pertinent information about potential conflicts, while compelling firms to have a “reasonable basis” for concluding that investments were in the best interest of their customers. This would ensure their fiduciary responsibility to clients was well defined and consequently, upheld. The thinking goes that reckless trading simply can’t take place in this type of environment.
The SEC’s proposal has been controversial, with investor advocates arguing that it isn’t as tough as imposing a so-called fiduciary duty on brokers. Being a fiduciary requires that finance professionals put their customers’ interests ahead of their own.
Reg BI was passed on June 5th but with amending.
Todd Cipperman, founding principal of Cipperman Compliance Services said that Reg BI won't satisfy anyone while at the same time making it harder to comply with.
“The SEC should reconcile the standard of care for advisers and broker-dealers that offer investment advice for retail clients. The proposed Reg BI is the worst of all worlds in that it changes the current broker-dealer standard without making it consistent with advisers,” Cipperman said. “With Reg BI, the SEC has essentially satisfied nobody. The brokerage community is displeased with a departure from the suitability standard. And, consumer groups don’t think the standard went far enough. I don’t believe regulation is the same as negotiating where the maxim that “the best solution is one that nobody is completely happy with” applies. The SEC should do the right thing, not the acceptable thing.”
If the SEC narrows the “solely incidental” exception to adviser registration (i.e. brokers can give advice that is solely incidental to their brokerage services), Cipperman added, then brokers may win the battle but lose the war.
“In other words, they may get a standard that is less than fiduciary, but a fiduciary standard will apply in most practical situations affecting advice for retail clients,” he concluded.
And Rep Maxine Waters, along with several other Democrats have been open in their disdain for Reg BI. Upon passage of Reg BI, she said the SEC regulation package (of which Reg BI was included) fell short by failing to require all financial advisors to adhere to “a strong, uniform fiduciary standard of care when providing investors with investment advice. She then called on the SEC to rescind Reg BI.
So, where does the market stand?
Well, it continues to police itself with the brokers keeping a closer eye on employees before any large and/or nefarious trades can take place. Reg BI and the soon-to-be-built audit trail are also steps in the right direction to stemming rogue trading and huge losses and while not foolproof, certainly help.
“No firm is going to want to see traders sidelined by force – rather they’d police themselves and abide by the patchwork rules in place,” said one trader. “Being sidelined for two weeks straight takes away my feel for the market. While my wife might like two weeks in Barbados, the firm won’t.’
This article originally appeared in the June 2008 edition of Traders Magazine
FINRA Advises on Rogue Trading
By Peter Chapman
Traders, FINRA says, should be required to take 10 consecutive trading days of vacation time so any unauthorized trades they might have made can be detected.
Barring the trader from accessing the firm's systems for 10 days will ensure any unauthorized trades will be exposed by the firm's trade reconciliation process during that time, FINRA notes.
FINRA's seven-page missive on the policing of unauthorized trading follows on the heels of a $7 billion loss at Societe Generale after junior trader Jerome Kerviel gambled without permission on index futures.
Citing "several recent cases" of rogue trading, FINRA in its memo presented a laundry list of steps a broker-dealer's management can take to make sure their firm is not done in by bad apples.
Besides mandatory vacation time, the steps include monitoring for trading limit breaches, large amounts of unrealized profits or losses, and unusual patterns of cancellations and corrections.
While rogue trading is not typically associated with rule-breaking, FINRA warns that it could result in "regulatory exposure." That's if it involves falsification of books and records; failures in supervisory controls; market manipulation; or fraud.
Most cases of rogue trading in recent years have involved anything but cash equities. Futures, bonds, currencies and commodities have been the instruments of choice.
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