FINRA publishes findings on manipulative trading as part of 2023 report
On January 10, 2023, US financial regulator FINRA (The Financial Industry Regulatory Authority) published its 2023 Report on FINRA’s Examination and Risk Monitoring Program.
Intended to provide insight on recent findings from the regulator and offer advice and best practices to FINRA member firms, the extensive and widespread report covers a number of new topics for 2023, including sections on Fixed Income Fair Pricing, Cybersecurity, Fractional Shares, and Regulation SHO.
Of particular note is a new section on Manipulative Trading. Included under the Financial Crimes header (also new for 2023), this section offers a succinct overview of the regulator’s recent findings on the practice of market abuse, with a particular focus on the trade surveillance measures being taken by firms to ensure abusive trading is being detected, flagged and punished.
To this end, the report emphasises three particular factors which contribute to insufficient market abuse surveillance.
FINRA’s Findings
The first of these factors is inadequate written supervisory procedures (WSP) with regards to trade surveillance. WSPs are documents outlining a firm’s supervisory procedures which must be submitted by any firm seeking approval to become a FINRA member. The regulator takes this opportunity to stress that trade surveillance procedures fall under the remit of WSPs and that surveillance hierarchies should be thoroughly documented as part of a firm’s WSP documentation.
In particular, FINRA stresses the importance of maintaining proper audit trails and explicitly defining escalation procedures in response to detected or potential market abuse.
If firms are concerned about their WSP, a trade surveillance solution with effective case management is a necessity. The ability to set up custom escalation flows, produce reports on user interaction with the system, and establish access permissions on a user-by-user basis should all be seen as must-haves.
As well as this, FINRA highlights the prevalence and detrimental impact of “non-specific surveillance thresholds’’. While many firms rely on static tolerances and alert thresholds, a truly effective trade surveillance system should possess the ability to test adaptively, dynamically altering alert thresholds based on factors such as asset type, instrument liquidity and market volatility. Not only does this greatly reduce false positives, it provides a far more indicative overview of abusive and manipulative trading regardless of unpredictable factors.
The final finding FINRA lists relates to broader deficiencies in surveillance, including a lack of ability to establish patterns of high-risk or manipulative behaviours, not adequately reviewing surveillance exception reports, and not including what one might call holistic factors - factors not directly captured by trade surveillance tools but which may indicate red flags worthy of investigation (including inquiries from regulators and lack of sufficient training).
Effective Practices
In order to rectify the issues caused by these findings, the regulator advocates for a number of effective practices intended to maximise efficient trade surveillance in financial firms.
Shared across all of these suggested practices, there seems to be a focus on increasing the scope of surveillance oversight enacted by firms. Rather than focusing on individual or small batches of trades, FINRA stresses the importance of being able to detect and flag longer-lasting iterations of market abuse, including manipulative trading schemes, cross-platform and cross-venue manipulation, and abusive algorithmic trading. Further to this point, the regulator emphasises the need to review trading activity on a macro basis, reviewing monthly exceptions based on a firm’s order entry and trading activity in a given period.
eflow’s Trade Surveillance platform offers solutions for all the requirements mentioned in the article above. If you’re unsure if your firm meets all the requirements laid out in FINRA’s report and would like to learn more about how eflow can help, book a consultation today.
