Firm Settles FINRA Charges for Intermarket Sweep Order Violations
Commentary by Glen Barrentine
A broker-dealer settled FINRA charges for violations of intermarket sweep order ("ISO") regulations and supervisory rules.
According to the AWC, the firm failed to take "reasonable steps" to ensure routed ISOs comply with the defined requirements, including executing against the full displayed size of protected quotes. FINRA found that the firm's system issues caused the firm to improperly route ISOs, leading to approximately 1,900 trade-throughs during the relevant period. These issues included incorrect configurations in its order management system and failures to route ISOs to certain market centers.
As a result, FINRA found that the firm violated Rule 242.611(c) ("Order Protection Rule: Intermarket Sweep Orders") of SEC Regulation NMS. FINRA also found that the firm violated Rule 242.611(a) ("Order Protection Rule: Reasonable Policies and Procedures") by failing to establish and maintain written policies reasonably designed to prevent trade-throughs. Although the firm implemented revisions to its supervisory procedures following a prior regulatory warning, FINRA found that the firm's supervisory system failed to detect significant compliance issues in real-time (relying on monthly reviews of order data, rather than daily or real-time reviews in violation of FINRA Rule 3110 ["Supervision"]). In addition, FINRA found that the firm's conduct violated FINRA Rule 2010 ("Standards of Commercial Honor and Principles of Trade")
To settle the charges, the broker-dealer agreed to (i) a censure and (ii) pay a $125,000 fine, of which $24,563 is payable to FINRA.
Commentary
The initial issue raised by the AWC concerns the timeliness of reviews. In this regard, the AWC states that the firm in question revised its WSPs to require the responsible principal to review its Reg NMS ISO Orders Report "in real time to identify trade-throughs." Notwithstanding this language, the AWC states that the firm actually reviewed the relevant report "at month's end." As a result, system issues, such as the ones the firm experienced, where not identified promptly. Indeed, in the example given in the AWC, a system issue that arose on October 28, 2019, was not identified until December 2019. This raises two issues. First, firms are required to comply with their WSPs. So, if the WSP says the review is to be done in real time but, in fact, it is not done until month end, or later, that is going to be a problem for FINRA. Second, in an automated system, such as the one in issue, waiting weeks or months to review key reports allows violations to pile up. In other words, a month end review of intermarket sweep orders is unlikely to be reasonable.
According to the AWC, in response to the initial problem, the firm revised its order management system ("OMS") but failed to undertake sufficient testing/monitoring of the revised OMS to ensure that it worked properly. FINRA found that the revised OMS failed to mark the destination code for Venue A, with the result that the OMS failed to route ISOs to that venue. This problem may have arisen from a reliance on and possibly a misunderstanding of the firm’s daily surveillance report. Indeed, it appears that the firm’s report relied on real-time monitoring of executions, but did not identify whether ISOs were received and executed as intended by the venues to which it directed the ISOs. Apparently, the firm did not notice that ISOs were not being sent to Venue A and did not identify this problem until it was brought to its attention by FINRA five months after it occurred. While the firm's daily ISO report may have been sufficient for the purpose for which it was created, it appears that it was not sufficient for testing whether the revised OMS system worked as intended. Any time a system is revised, firms should undertake careful testing and monitoring to ensure that the revised system is functioning appropriately. In conducting testing and monitoring, firms should ask whether existing surveillance is sufficient or whether something more may be needed to fully validate the revised system.
Finally, the AWC states that the firm failed to update its OMS to add destination codes for new exchanges with the result that the firm did not route ISOs to these exchanges. In other words, it appears that the firm did not have a process in place to monitor for the need to update the venues to which ISO orders should be sent. It is not enough to have a process that works today; firms must also have a process in place to monitor for items that may require updates or changes to be made to keep the current process working.