Mistakes in computer coding by a high frequency trading firm that went undetected for approximately four years were responsible for approximately 12.6 million orders that violated Reg NMS, according to an Order settling an enforcement proceeding with Latour Trading LLC, announced by the SEC on September 30. These noncompliant orders involved more than $4.6 billion shares and had a notional value of $116 billion.
Once again, firms are reminded of the need to have robust controls over their complex computer systems, the need to educate and train IT staff on regulatory compliance issues, and the potential for large-scale violations resulting from computer errors, particularly errors in high frequency, high volume trading systems.
The errors here were made in connection with Intermarket Sweep Orders (“ISO”) that were used extensively by Latour’s algorithmic trading systems. Although Latour’s trading systems were designed to route ISO orders to the correct exchanges in accordance with Latour’s requirements under Reg NMS, a programming modification in 2011 inadvertently caused certain routing destination codes to be deleted, and the ISO orders were not actually sent to certain exchanges as was required under Reg NMS.
The SEC Order indicates that this programming change was made by technical personnel employed by Latour’s parent corporation, in violation of SEC Rule 15c3-5, which requires that Latour have “direct and exclusive control” over its financial and regulatory risk management controls. The person making the modification deleted certain lines of computer code that he believed created “operational inefficiencies,” and did not understand that the change would affect the routing of Latour’s ISOs.
Latour’s post-trade surveillance tools did not catch the error because they reviewed the ISO orders as they had been generated by the trading algorithm, but before the routing codes were removed, thereby examining only the orders the firm intended to send to the various exchanges and not the orders that were actually sent. The Order also noted that Latour had other means to detect the errors, including execution reports from the exchanges, but failed to do so.
As explained in the Order, violations of the ISO rules may adversely affect other market participants who could lose beneficial executions they otherwise might have received; violations also may cause locked or crossed markets. Here, the SEC charged that as a result of the coding errors and additional flaws in the firm’s order routing logic, Latour caused more than 1.1 million trades to be executed at a price worse than the best available price and more than 1.7 million locked or crossed markets.
Under the settlement, Latour agreed to pay a $5 million civil penalty and more than $3 million of disgorgement, representing gross trading profits, rebates received from the exchanges and interest.