SEC Proposes Rule Extending FINRA Registration Membership to Currently Exempted Proprietary Trading Firms
On March 25, 2015, the U.S. Securities and Exchange Commission
(SEC) voted unanimously to issue a proposed rule amendment that
would significantly narrow the existing exemption that permits many
proprietary-trading broker-dealers to operate without being a
member of the Financial Industry Regulatory Authority
(FINRA).
Section 15(b)(8) of the Securities Exchange Act of 1934 requires a
registered broker-dealer to belong to a registered national
securities association, i.e., FINRA, unless it is a member of a
national securities exchange and trades securities only on that
exchange. SEC Rule 15b9-1 currently expands the statutory exemption
from FINRA membership for broker-dealers that 1) are members of a
national securities exchange; 2) carry no customer accounts; and 3)
have "annual gross income" of less than $1,000 from
over-the-counter securities transactions (which the SEC calls the
"de minimis allowance"). A broker-dealer does
not have to count income derived from off-exchange transactions for
the firm's own account with or through another broker-dealer
towards the de minimis allowance. The proposed rulemaking
would eliminate the de minimis allowance, which the SEC
says has been used in a way that departs significantly from the
original regulatory intent underlying Rule 15b-9, including, in
particular, by firms that employ what are commonly labeled
"high frequency trading strategies."
The de minimis allowance would be replaced by a
requirement that for the exception from FINRA regulation to apply,
a broker-dealer must, in addition to being a member of a national
securities and carrying no customer accounts, effect no
off-exchange securities transactions whatsoever except in two
cases: 1) Where the dealer conducts trading on a physical exchange
floor, but engages in off-exchange transactions for the
dealer's own account with or through another registered broker
dealer where those transactions are solely for the purpose of
hedging the risks of the dealer's floor-based activities; or 2)
Where the broker-dealer's only off-exchange transactions result
from orders that are routed by the exchange of which the
broker-dealer is a member in order to prevent trade throughs as
required by SEC Regulation NMS Rule 611.
The effect of the proposed rule change, if adopted, will be to
require proprietary trading firms that are not FINRA members, and
that trade on dark pools or other alternative trading systems, to
join FINRA.
Joining FINRA can be expected to introduce some additional
compliance obligations and corresponding costs for previously
exempted firms. This is particularly true given FINRA's
recently stated commitment to develop a series of initiatives
relating to equity market structure and automated trading
activities, exemplified most recently by the FINRA notice described
in the next section of this alert.
The proposed rule amendment to Rule 15b9-1 has not yet been
published in the Federal Register. Once it is, a 60-day
public comment period will be open and industry participants and
the public at large will be able to weigh-in on the SEC's
proposal. See SEC Release No. 34-74581.
FINRA Seeks Comment on Proposed Registration of the Principal Developers and Supervisors of Algorithmic Trading Strategies
In late March, FINRA issued Regulatory Notice No. 15-06 (the
Notice), requesting comment on a proposal that would require the
registration of associated persons (APs) who are involved in the
design, development, or significant modification of algorithmic
trading strategies. Noting certain recent examples in which
algorithmic trading strategies resulted in problematic conduct,
including improper trading activities and possible securities law
violations, the Notice explains FINRA's belief that requiring
the registration of APs primarily responsible for or supervising or
directing those primarily responsible for the design, development,
or significant modification of algorithmic trading strategies would
better educate individuals involved in the algorithm development
process regarding trading rules and securities laws, and prevent
future violations.
The Notice proposes to define "algorithmic trading
strategies" to mean "any program that generates and
routes (or sends for routing) orders (and order-related messages,
such as cancellations) in securities on an automated basis."
An order router alone would not constitute an algorithmic trading
strategy.
FINRA also explains that it does not intend to require the
registration of all technology personnel who play a role in the
deployment of an algorithmic trading strategy. For this reason, the
proposed focus is on those who are principally responsible for or
who supervise or direct on a day-to-day basis those who are
principally responsible for the design, development, or significant
modification of the algorithmic trading strategies. Junior
developers and others who solely write code to implement design or
modification instructions, and supervisors of lead developers not
involved in day-to-day supervision or direction of the development
process, are among those who would not be required to register.
Where a member engages a third party to build an algorithmic
trading strategy, the AP directing the third-party in designing and
developing the algorithmic trading strategy would be required to
register.
The Notice also proposes that covered associated persons would be
required, in addition to passing the examination and becoming
registered, to meet continuing education requirements every three
years (pursuant to FINRA Rule 1250).
The Notice seeks comment from members on its proposed definition of
the scope of these categories and on other related issues. Comments
must be received by May 18, 2015.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.