FINRA Starting Sweep on ATS Practices
February 13, 2013
The Financial Industry Regulatory Authority is about to pay visits to a wide range of alternative trading systems, in an attempt to make sure they are properly handling customers' orders.
The independent regulator of brokers, which shares oversight of alternative trading systems with the Securities and Exchange Commission, has made ATS operations one of its top priorities in 2013, according to John Malitzis, executive vice president of market regulation at the agency. [IMGCAP(1)]
The examiner will conduct an initial sweep of about 15 of the systems, which are typically set up to help match buyers and sellers of large quantities of stocks who want to trade anonymously. These can include crossing networks, such as ITG's Posit or Goldman Sachs' Sigma X, which match trades without first routing orders to a public exchange; block-trading venues such as Liquidnet or the BIDS ATS; and electronic communications networks, which display public quotes, such as LavaFlow, operated by Citigroup, or Light Pool, operated by Credit Suisse.
The systems that allow anonymous trading off public exchanges are typically called dark pools. The largest of these is Crossfinder, also operated by Credit Suisse.
"They're going to be looking at the usual suspects," said James J. Angel, a market structure expert and visiting associate professor at the Wharton School of the University of Pennsylvania.
Dark pools accounted for 13.3 percent of all equities trading in 2012, according to Rosenblatt Securities. In January, 2.4 billion shares of stock were traded off exchanges, according to NYSE Euronext, accounting for 36.7 percent of all trading.
"We are looking at the use of indications of interest, whether the firm trades as principal or riskless principal within the ATS, and whether and how this is disclosed to ATS subscribers. We are also looking at the method by which the ATS generates compensation, how customer errors are handled, and whether and how affiliates of the ATS interact with order flow," Malitzis said.
Indications of interest, or IOIs, are nonbinding offers to buy or sell securities, communicated within alternative trading systems. Riskless principal is a characteristic of a trade in which a member who has received a customer order immediately executes an identical order in the marketplace, while taking on the role of principal, in order to fill the customer order.
"There's been a lot of concern," Angel said, about "when is an IOI an IOI and when is it really an order."
If an IOI is an order, he noted, then the quote must be reported to the Order Audit Trail System managed and operated by FINRA.
A widespread set of fines for OATS violations could be "just the thing for the FINRA budget," Angel said.
Also on the priorities list for review are how the systems handle errors, how confidential information on customers' orders get handled and whether any interaction occurs between an ATS and any affiliated organizations.
Last fall, the SEC fined the LeveL ATS $800,000 for failing to properly safeguard customer information. In that case, the smart order router of LeveL's technology provider, the Lava Trading unit of Citigroup, kept in its memory information about LeveL subscribers' unexecuted orders. The router then used that information to make routing decisions for the benefit of its own order-routing business.