The two principal self-regulatory bodies, in what could prove a boon for sellside trading departments, are on track to remake their trading ahead rules.
The Financial Industry Regulatory Authority and NYSE Regulation are working together to “harmonize” their rules governing the practice of brokers trading ahead or trading along with customer orders. If they reach agreement, FINRA’s Manning Rules and the NYSE’s Rule 92 will look very similar, easing brokers’ compliance burden.
“We want to be as identical as possible so that there is one standard,” Tom Gira, executive vice president in FINRA’s Market Regulation Department, said at a recent conference.
The differences in the two rules reflect the historic differences between the dealer market and the exchange market, John Malitzis, executive vice president for Market Surveillance at NYSE Regulation, told attendees at the same conference. “Given the current changes in market structure and the fact that business models have blended and harmonized, it makes sense for us to harmonize those rules.”
NYSE Regulation has already made one change to Rule 92 to bring it more in line with Manning. In 2007, the regulator permitted members to exclude riskless principal trades from their obligations under the rule. The NASD had done so in 2002.
The move to harmonize the two rules is part of a master plan by the two regulators to eliminate as many duplications from their respective rulebooks as possible. The plan was the driving force behind the merger of the NASD with parts of NYSE Reg in 2007.
Earlier this year, both FINRA and NYSE Reg put out notices to their members asking for comment on the joint proposal. FINRA proposes to merge its two Manning Rules — one for limit orders and one for market orders — into a single rule, Rule 5320. NYSE Reg plans to merge its two Rule 92 rules — one for the NYSE and one for NYSE Amex – into one. The comment period ended in April and now the two organizations are mulling their next step.
Perhaps the biggest benefit from any harmonization to accrue to broker-dealers will be a liberalization of the provisions of the NYSE’s Rule 92 dealing with customer consent on institutional trades. Currently, under the rule, brokers must obtain order-by-order or blanket consent from customers before a broker can trade ahead of the customer’s order. The industry has long complained that the provision is unnecessary and overly cumbersome. “It imposes unnecessary delays in the trading process,” Ann Vlcek, associate general counsel of the Securities Industry & Financial Markets Association, told FINRA and NYSE Reg in a comment letter.
NYSE Reg has proposed adopting the disclosure provisions of the Manning Rules. That way brokers would only be required to inform their customers about their trading ahead practices on a periodic basis. The terms would be subject to negotiation, but brokers would not have to contact their customers every time they wanted to trade alongside their orders and request permission.
“Disclosure of the relevant terms and conditions, as in the existing FINRA rule, is easier for firms to control and implement and provides direct disclosure to customers without the administrative burden of ensuring that customers return a response,” Vlcek stated. SIFMA believes such disclosure could be provided when customers open accounts and annually thereafter.
NYSE Reg gave a little ground on the issue two years ago when it permitted NYSE members to obtain affirmative consent from their clients on a one-off blanket basis. Brokers have found that solution unworkable, however, according to Vlcek, and still typically seek consent with each order.
Despite NYSE Reg’s apparent turnabout on the issue, as evident by its Information Memo #09-13, it is still unclear as to whether NYSE Reg will adopt FINRA’s approach to consent.
“It’s harder to move from a regime where you have order-by-order consent, where a customer is consenting to something, to a disclosure regime,” Malitzis told attendees at SIFMA’s annual Market Structure Conference. “The regulatory structure around order-by-order consent is a better approach.” Malitzis emphasized the opinion was his own and may not reflect that of NYSE Regulation.
He added: “I recognize there are costs associated with that. They can be significant costs. We are looking for an analysis of the cost-versus-benefit of applying this across the board.” Malitzis also concedes that buyside traders should probably be doing their own policing. “This ties in with personal responsibility,” he said “Their responsibility as a fiduciary or as a proprietary trader is to really understand how the firms are trading their orders.”
By contrast, Gira has no qualms about a disclosure regime. “Disclosure provides the benefits,” he said at the SIFMA conference. “But it is reasonable to expect that people could differ on this.”
There are at least two other key changes to their respective rules being considered by FINRA and NYSE Reg. FINRA is considering the adoption of the so-called “no-knowledge” exception of Rule 92. The exception permits dealer desks to trade at the same price as a customer order as long as the trader is unaware of the order. NYSE Reg recognizes that a firm may operate several desks, any one of which has no knowledge of the activities of another.
FINRA has a no-knowledge exception, but it only applies to a firm’s proprietary trading desk. It does not apply to a market making desk. FINRA has proposed extending the rule to cover market making desks as well. Because more of a firm’s retail flow is bypassing the market making desks and heading out the door, FINRA believes times have changed enough to grant market makers a no-knowledge exception. Any exception would apply to listed securities only; not for orders in over-the-counter securities. SIFMA is in favor of the change, but believes it should encompass OTC desks as well.
For its part, NYSE Reg is considering revising Rule 92 to mimic Manning in how it treats the event that triggers the rule. Under Rule 92, a broker becomes obliged to the customer at the time he receives an order. Under Manning, the broker is obliged only after he does a trade for his own account. NYSE Reg is proposing its members be allowed to trade first and then satisfy their trading ahead requirements.
SIFMA is in favor of the change. Because a trader may be working several proprietary and customer orders across multiple market centers at the same time, it can be counterproductive to cancel a proprietary order to comply with Rule 92, SIFMA argued. “When a new customer order arrives, it makes more sense to protect the new order with any potential fills from existing outstanding firm orders,” Vlcek said, “as opposed to canceling the outstanding firm order until the firm fills the new customer order.”
Any changes to the SROs’ rules must be approved by the Securities and Exchange Commission. “We will determine jointly whether to file a rule change and what it will look like,” Gira said. In response to a Traders Magazine inquiry, NYSE Reg officials would only say they are “assessing our next move.”
