RIA Compliance Blog
The Securities and Exchange Commission (“SEC”) recently approved a proposed Financial Industry Regulatory Authority (“FINRA”) rule change which will require associated persons responsible for the design, development, and significant modification of algorithmic trading strategies, or the supervision of such activities, to register as Securities Traders. This development highlights the increasing regulatory and enforcement focus FINRA & the SEC are placing on the use of trading algorithms in the financial services industry.
Currently, associated persons are required to register as Securities Traders if they are engaged in proprietary trading, the execution of transactions on an agency basis, or the direct supervision of such activities with respect to off-exchange transactions in equity, preferred or convertible debt securities. FINRA is expanding this requirement to include associated persons who are: 1) primarily responsible for the design, development or significant modification of algorithmic trading strategies; or 2) responsible for the day to-day supervision or direction of such activities.
The phrase “algorithmic trading strategy” is defined in the proposed rule as an automated system that generates or routes orders or order related messages. The registration requirement applies whether the orders are ultimately routed (or sent to be routed) to an exchange or over the counter. FINRA has already noted various types of automated systems that could fit within this definition, including arbitrage strategies such as index or exchange-traded fund arbitrage, hedging or loss-limit algorithmic strategies that generate orders on an automated basis, trading strategies that becomes more or less aggressive to correlate with trading volume in specified securities, and trading strategies that generate orders based on moving referencing prices, among others.
The above definition does not include automated systems that solely route orders received in their entirety to a market center for handling and execution. In order to be included within the definition, the automated system must generate orders into the marketplace or execute trades without material human intervention. An algorithm that solely generates trading ideas or investment allocations, such as an automated system that constructs recommended portfolios, but that does not automatically generate orders into the marketplace would not constitute an algorithmic trading strategy either.
Associated persons covered by the amended registration requirement must pass the Series 57 qualification examination and comply with the continuing education requirements applicable to Securities Traders. By ensuring the registration of one or more associated persons that has knowledge of and responsibility for the design and/or implementation of the algorithmic trading strategy, FINRA hopes to combat problematic conduct stemming from algorithmic trading strategies.
FINRA will announce the effective date of the proposed rule change in a Regulatory Notice no later than June 6, 2016. The effective date will be no later than 300 days following SEC approval, or February 1st of 2017.
Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.