WASHINGTON, D.C. — The current options audit trail is not sufficient for regulators to spot rules violators and market manipulators, the chief regulator of the brokerage industry said Thursday.
The existing trail does not capture order receipt or transmission times, for instance, said Richard Ketchum, chief executive of the Financial Industry Regulatory Authority.
“We are often in a position where we need to get information about order receipt times from firms in order to assess a firm’s knowledge of the existence of an order and potential culpability, and to determine whether there has been harm to customers’’ in potential rule violations, such as front-running of customer orders, he said.
The Consolidated Audit Trail proposed by the Securities and Exchange Commission, which will step up the amount of detail required to be to delivered to regulators overnight “will enable us to close the regulatory gaps that current exist” on stocks and options,’’ he said, at the Security Traders Association market structure conference here.
“As with equities, the inclusion of more detailed customer records will help us aggregate related options activity and identify bad actors,’’ he said.
The rule adopted by the SEC in July that mandates exchanges and FINRA to develop a consolidated audit trail requires the collection of details on every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options across all U.S. markets.
Ketchum’s comments follow those made at an options conference sponsored jointly by the Futures Industry Association and the Options Industry Council where senior vice president Gene DeMaio said FINRA is investigating newly discovered types of “mini manipulation,” or the trading of an option’s underlying equity in order to profit from movements in the price of the option.
“This is an area of interest for us,” DeMaio said. “We’re spending a lot of time on it.”
The mini manipulation occurs when a trader with a large position in an option trades a small amount of the underlying stock in order to drive the option into an in-the-money status. Often done in illiquid securities, this tactic produces a profit for the trader and is illegal.
The speed of trading can amplify the effects of a manipulation, Ketchum said, “because a move in the underlying equity will instantaneously impact the option pricing.”
This means a manipulator does not need to move the stock but for a moment, to impact the options markets, Ketchum said.
Ketchum also said FINRA has developed surveillance alerts designed to spot excessive message traffic in options, a phenomenon already being addressed in and by equities exchanges.
FINRA is observing cases where it has seen “several thousand options quote updates in one second without a change in the underlying price,’’ he said.
“We have received a large number of complaints in this area and we’re looking at the reasonableness of the controls surrounding the algorithms and whether firms have the appropriate pre-trade checks in place,’’ he said.
In many instances, “the microbursts of activity are often due to algorithms that trip over themselves’’ Ketchum said FINRA has been told.
