Firm Settles FINRA Charges for Mismanaging Order Algorithms
Commentary by Glen Barrentine
A firm settled FINRA charges for improperly programming trading algorithms, which resulted in orders being improperly sent to the market.
According to the AWC, the firm generated orders through three trading algorithms. The three algorithms generated standard limit orders and market maker peg orders ("MMPOs"). MMPOs are limit orders that are continuously repriced by the exchange to a specified offset from the National Best Bid or Offer ("NBBO").
FINRA found that the firm deployed a technology change to its trading engine before the open, that resulted in the firm’s outgoing orders for the three algorithms not containing an MMPO instruction. The orders triggered the firm's price band risk control, a pre-trade hard block that rejects orders priced at a specified percentage through the reference price (i.e., the last sale or the previous day’s close if no last sale), which, in turn, triggered internal rejection alerts and prevented the orders from being sent to the market. FINRA said the firm manually disabled the control for the three algorithms to allow the orders to be sent to the market. FINRA found that the firm did so based on a failure to detect the impact of the technology change on its MMPOs and a mistaken conclusion that the price band risk control was malfunctioning. As a result, the firm routed a total of 635 orders to the market with limit prices significantly away from the prevailing NBBO.
FINRA also found that the firm’s risk management controls and supervisory procedures failed to prevent the orders being erroneously submitted.
FINRA determined that the firm violated SEA Section 15(c)(3), Rule 15c3-5(b) and (c)(1)(ii) ("Risk management controls for brokers or dealers with market access"), and FINRA Rules 3110 ("Supervision) and 2010 ("Standards of Commercial Honor and Principles of Trade".)
To settle the charges, the firm agreed to (i) a censure and (ii) a total fine of $100,000.
Commentary
It is likely this AWC could have been avoided had the firm adequately tested the impact of the technology change on its trading engine. The firm compounded its mistake by failing to carefully evaluate the internal rejection alerts that resulted when the firm’s initial orders were blocked by the firm’s systems. As discussed in the AWC, a contributing factor to this failure was the fact that the firm did not have written policies, procedures, or controls regarding the process and criteria for overriding or disabling a market access risk control, including the circumstances under which firm personnel could disable the firm’s price controls. Had such policies, procedures and controls been in place, it is unlikely the firm would have made the decisions it did.