FINRA Fines Firm for Trade-Through Violations
Commentary by Glen Barrentine
A firm settled FINRA charges for executing off-exchange trade-throughs and related supervisory failures.
According to the AWC, the firm executed more than 11,000 off-exchange trade-throughs that it reported with an Outbound ISO Exception modifier, even though systemic latency issues prevented the trades from being executed simultaneously. FINRA stated that these delays, which sometimes exceeded one second, resulted from programming choices in two components of the firm’s electronic order management systems. FINRA said that the delays were unintentional and not designed to secure better pricing for customers. FINRA determined that the Outbound ISO Exception did not apply under those circumstances. FINRA further determined that one of the firm’s systems processed market data only for the top eight levels of quotations from each exchange. FINRA stated that this limitation caused the firm to miss protected quotes beyond those levels and to execute additional trade-throughs without routing the required ISOs.
FINRA found that the firm also allowed off-exchange trade-throughs to occur through manual execution and routing errors. FINRA stated that a trading desk executed customer facilitation and position transfer orders outside of the national best bid and offer during market hours, resulting in additional trade-throughs that did not qualify for an exception under Regulation NMS. FINRA said that the firm routed ISOs containing incorrect clearing firm information, causing exchanges to reject thousands of orders and leading to more trade-throughs without the required ISO routing. FINRA concluded that the firm did not perform ongoing surveillance of its Regulation NMS compliance program, allowing these operational and supervisory failures to persist over several years.
FINRA determined that the firm failed to establish a supervisory system reasonably designed to detect and prevent trade-through violations. FINRA stated that the firm lacked procedures to identify or review trade-throughs reported with an Outbound ISO Exception modifier when the required ISOs were not routed simultaneously. FINRA found that the firm’s supervisory manuals provided no guidance for reviewing the validity of exception modifiers. FINRA further stated that the firm’s supervisory framework was not designed to capture trade-throughs caused by its systems’ limited market data processing. FINRA found that the framework also failed to address manually executed trades outside the national best bid and offer or exchange rejections of ISOs that resulted in unprotected transactions.
FINRA concluded that the firm violated Rule 611 of Regulation NMS ("Order protection rule") as well as FINRA Rules 2010 ("Standards of Commercial Honor and Principles of Trade"), 3110 ("Supervision"), and 6380A ("Transaction Reporting").
To settle the matter, the firm agreed to (i) a censure and (ii) a $155,000 fine, resolved simultaneously with similar matters for a total fine of $450,000.
Commentary
The trade-through rule, also known as Rule 611 of Regulation NMS, is intended to ensure that orders do not execute at prices that are inferior to the best protected bid/offer on any "trading center." Orders executed at a price that is inferior to protected bids/offers are considered to "trade through" the better priced orders.
Rule 611(a)(1) requires "trading centers" to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs that do not fall within one of the exceptions to the rule (discussed further below). The term "trading centers" includes any "exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent." Rule 611(a)(2) requires trading centers to conduct regular surveillance to ascertain the effectiveness of its Rule 611 compliance and to remedy any deficiencies.
The trade-through rule is subject to a number of exceptions. Among these, and most relevant to the AWC at hand, is an exception for intermarket sweep orders or ISOs. Specifically, the execution of an order identified as an intermarket sweep order constitutes an exception to the rule’s prohibition.
The term "intermarket sweep order" is defined at Rule 600(b)(47) of Regulation NMS to mean a limit order for an NMS stock that is (i) identified as an intermarket sweep order and, (ii) simultaneously with the routing of the ISO, one or more additional limit orders, as necessary, are routed to execute against the full displayed size of any protected bid in the case of a limit order to sell, or the full displayed size of any protected offer in the case of a limit order to buy, for the NMS stock with a price that is superior to the limit price of the limit order identified as an intermarket sweep order. These additional routed orders also must be marked as intermarket sweep orders.
In the AWC, it appears that, over a period of years, the firm executed 11,089 off-exchange trade-throughs that it reported with an Outbound ISO Exception modifier even though systemic latency issues prevented the firm from executing the trade-throughs simultaneously. The AWC states that the delays occasioned by these latency issues, which sometimes exceeded one second, were unintended consequences of the firm’s programming choices.
During this period, the firm also executed additional trade-throughs on account of:
- A failure to consider protected quotations below the top eight quotations in an exchange’s feed, resulting in 42 potential trade-throughs;
- Manually executed orders outside the NBBO, resulting in 47 trade-throughs;
- Routing ISOs with incorrect Financial Information eXchange (FIX) protocol tags "resulting in exchang[es] rejecting 3,475 ISOs," that resulted in "23 trade-throughs without routing necessary ISOs."
It is also significant that, in 2018, the firm was previously fined by both FINRA and CBOE BYX Exchange and Cboe BZX Exchange for violations of the trade-through rule.
The AWC highlights the difficulty of compliance in light of changes and increased complexity in the equity markets since the Rule’s adoption in 2005. These changes include a significant increase in inter-connected markets, increased reliance on automation, and vastly increased execution and routing speeds.
The SEC recently hosted a roundtable on trade-through prohibitions. See SEC Press Release 2025-109. Topics at this roundtable included a discussion of (i) market participants’ experience with the trade-through prohibitions; (ii) trade-through prohibition’s rule in today’s highly automated and connected market structure; and (iii) potential paths forward for trade-through prohibitions.