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With market regulators more active on both sides of the Atlantic, market participants face a higher bar for compliance across an array of activities, prominently including monitoring and surveillance of their own trading.
The U.S. Securities and Exchange Commission (SEC) has been flexing its muscles under chair, Gary Gensler, with dozens of rule-change proposals, as well as a meaningful step-up in enforcement actions. In the U.K., 2022 was an “unprecedented” year for the Financial Conduct Authority (FCA), as it took “extensive action in advancing a number of regulatory initiatives,” according to Gibson Dunn.
Underscoring the heightened importance of firms ensuring the integrity of their trading, the Financial Industry Regulatory Authority (FINRA), for the first time, included a section on manipulative trading in its annual report aimed at helping broker-dealer members strengthen their compliance programs. The 2023 Report on FINRA’s Examination and Risk Monitoring Program ”addresses topics that remain perennially important, with updates to reflect evolving risks, industry trends and findings from FINRA’s recent oversight activities,” Greg Ruppert, EVP, Member Supervision at FINRA, said in a release last month. “This year, we have also increased the breadth of the report’s coverage by adding several new topics focused on insights originating in our market surveillance activities.”
Regulators have noted that effective trade surveillance entails the right technology systems in place, as well as the processes and protocols that make the best use of that technology.
FINRA, an industry group that works under the supervision of the SEC, highlighted eight considerations for market participants to consider in assessing their trade surveillance. These include determining whether systems monitor for patterns of suspicious order entries, trades that don’t make economic sense and red flags of potential coordination among customers; determining thresholds for surveillance controls; ensuring that supervisory procedures are adequate; ensuring that policies and procedures adjust to changes in the firm’s business model and to new customers; and proper testing of and change documentation for surveillance systems.
The report presented a trio of areas that can trip up firms: inadequate written supervisory procedures, non-specific surveillance thresholds and surveillance deficiencies. That’s followed by a half-dozen effective practices, leading with “Maintaining and reviewing customer and proprietary data to detect manipulative trading schemes (e.g., momentum ignition, layering, front running, trading ahead, spoofing, wash sales, prearranged trading), including those that involve correlated securities, such as stocks, exchange-traded products (ETPs) and options.”
Market operators and technology providers, who partner with broker-dealers for their surveillance and monitoring, have taken notice of the increasing emphasis on getting this function right. Financial services firms were projected to spend $1.8 billion on surveillance last year, up 20% from 2021, Coalition Greenwich said in a November 2022 report.
“This release from FINRA is yet another example of a regulator providing more focused guidance on trading risks and how firms can better mitigate them,” Nasdaq said in a recently published paper. “It is more essential than ever that compliance practitioners are paying close attention to the processes supporting their surveillance technology stack to more effectively monitor for market abuse and meet regulatory expectations.”
