Last week, a broker-dealer was fined US $1.575 million by the Financial Industry Regulatory Authority and other self-regulatory organizations for not complying with market access requirements for gatekeepers.

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  • Broker-Dealer Sanctioned US $1.575 Million by FINRA and Other SROs for Market Access Rule Violations: Instinet LLC agreed to pay a fine of US $1.575 million to resolve charges by the Financial Industry Regulatory Authority, as well as by five exchanges and certain of their affiliated exchanges, for allegedly violating the Securities and Exchange Commission’s Market Access Rule. The purported wrongful conduct occurred from August 2012 through at least November 2017.

Under Reg MAR – adopted by the SEC in 2010 – broker-dealers with market access, or that provide a customer or any other person with access to an exchange or an alternative trading system, are obligated to have a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory and other risks, including legal and operational risks, related to market access. Reg MAR is intended to prevent the entry of erroneous orders and orders that exceed pre-set credit or capital thresholds by each broker-dealer and each of a broker-dealer's customers (including other broker-dealers, individuals or institutions such as hedge funds) through mandatory pre-order entry checks, and was meant to eliminate so-called "naked access" (e.g., orders not subject to any pre-trade filters). (Click here to access Reg MAR, Rule 15c3-5.)

According to FINRA, during the relevant time, Instinet failed to have adequate risk management controls and supervisory procedures to mange the financial, regulatory and other risks associated with its market access business. FINRA claimed that the firm did not ensure compliance with all its requirements under Reg MAR, including “supervising client trading to detect and prevent potentially violative layering, spoofing and wash trading.”

As an example of the firm’s alleged violations, FINRA claimed that, from August 2012 through January 2014, Instinet maintained an exception report that flagged pre-open placement and cancellation of orders that exceeded 10 percent of a security’s 30-day average volume. However, this exception process failed to identify two customers whose problematic pre-open orders exceeded the firm’s threshold because of a programming error that replaced the comma used as a separator in numbers with a period. Thus, an order for 100,000 shares would be viewed as an order for 100 shares. As a result, Instinet failed to review potentially non-bona fide transactions on 75 instances during the review period.

As part of its settlement, Instinet also agreed to certain undertakings, including filing with FINRA within 90 days a representation that it has implemented controls and procedures reasonably designed to ensure its compliance with Reg MAR.

The five principal exchanges that joined FINRA in its enforcement action were the BOX Options Exchange, LLC, the Cboe BZX Exchange, Inc., Investors Exchange, LLC, The NASDAQ Stock Market, LLC, and the New York Stock Exchange.

Compliance Weeds: In July 2017, four broker-dealers agreed to pay an aggregate fine of US $4.75 million to resolve charges brought by FINRA and various securities exchanges for violating Reg MAR. According to FINRA and the exchanges, the firms failed to comply with one or more provisions of Reg MAR, including not implementing controls to prevent the entry of mistaken or duplicate orders, orders that were in excess of pre-set credit or capital limits or orders that might constitute potentially violative or manipulative orders. (Click here for background in the article “Four Broker-Dealers Agree to Pay Aggregate Fine of US $4.75 Million to FINRA and Various Exchanges for Allegedly Violating SEC Market Access Rule” in the July 30, 2017 edition of Bridging the Week.) Earlier this year, FINRA indicated that compliance with Reg MAR would be a focus of its 2018 examination of members. (Click here for details in the article “FINRA Announces 2018 Examination Priorities; Will Review Role of Firms and Salespersons in Facilitating Cryptocurrency Transactions and ICOs” in the January 15, 2018 edition of Bridging the Week.)

As a result, broker-dealers should routinely review their market access written policies and procedures to double-check they reflect current practices, and examine market access gatekeeper systems to ensure that all relevant customers’ orders are routed through such systems, and that the systems are achieving the purpose for which they were designed. This likely involves reviewing the adequacy of all data feeds and evaluating sample output against input to ensure the output is likely correct.

Both the SEC and FINRA offer extensive resources to help broker-dealers comply with their obligations under Reg MAR. (Click here to access the SEC’s Answers to Frequently Asked Questions related to Reg MAR and here to accessReport on FINRA’s Examination Findings (December 2017), section of Market Access Controls (pages 9-10).)