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.”
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.
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J. Craig Long