On April 7, the Securities and Exchange Commission (SEC) approved amendments to NASD Rule 1032(f) which will require registration as Securities Traders of associated persons who are primarily responsible for the design, development or significant modification of algorithmic trading strategies, or who are responsible for the day-to-day supervision or direction of such activities. By requiring these individuals to pass a qualification examination (and, like all registered individuals, subsequently to take part in continuing education) concerning basic securities regulation obligations, the Financial Industry Regulatory Authority (FINRA) hopes to facilitate compliance with such regulatory obligations by firms engaged in algorithmic trading activities.
Description of the Requirements of the Amended Rule
Under the approved amendments to NASD Rule 1032(f), associated persons of FINRA member firms will be required to pass a qualification examination and register with FINRA as Securities Traders if they are:
- primarily responsible for the design, development or significant modification of an algorithmic trading strategy relating to equity (including options), preferred or convertible debt securities; or
- responsible for the day-to-day supervision or direction of such activities.
The amended rule defines algorithmic trading as "an automated system that generates or routes orders (or order-related messages)" and applies whether such orders and order related messages ultimately are routed (or sent to be routed) for execution in the over-the-counter market or to an exchange. Examples of algorithmic trading strategies covered by the amended rule include an automated arbitrage strategy (e.g., index or exchange-traded fund arbitrage), an automated hedging or loss-limit algorithmic strategy that generates orders, or a trading strategy that generates orders based on moving reference prices. However, an automated system that solely routes orders received in their entirety to a market center is not considered an algorithmic trading strategy.
Examples of the Application of the Amended Rule
FINRA has stated that it does not intend the registration requirement to apply to every associated person who touches or otherwise is involved in the design or development of a trading algorithm. Instead, the intent is to ensure that at least one associated person that possesses knowledge of (and responsibility for the design of) the intended trading strategy and the technological implementation of that strategy, sufficient to evaluate whether the system is designed to achieve regulatory compliance, is registered. A few examples of the application of the amended rule are set forth below:
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Designation of Securities Traders to a Principal
Pursuant to FINRA Rule 3110(a)(5), individuals registered under the new rule as Securities Traders (like all registered personnel) must be assigned to a registered principal with the authority to carry out supervisory responsibilities of the firm. However, the amended rule does not necessarily trigger a registration requirement for the current supervisor of algorithm design or development personnel if that supervisor is not responsible for the day-to-day supervision or direction of the design or development process. Indeed, it may be appropriate for a firm to assign a lead algorithm developer (or other non-trader) who is required to register as a Securities Trader, to an individual who supervises trading activities (i.e., who is outside of the developer's usual reporting line), so long as the supervisor in question is registered as a Securities Trader or a Securities Trader Principal. Another registered person may be assigned to supervise the lead developer (or other non-trader) with respect to other areas applicable to registered representatives generally (e.g., outside business activities).
To register with FINRA as a Securities Trader, an individual must first pass the Series 57 (Securities Trader) examination. To register with FINRA as a Securities Trader Principal, an individual must qualify and register as a Securities Trader and must pass the Series 24 (General Securities Principal) examination.
FINRA will announce the effective date of amended NASD Rule 1032 in a Regulatory Notice by June 6. The effective date will be no sooner than 180 days after publication of such Regulatory Notice and no later than 300 days after April 7.