FINRA Fines Broker-Dealers for Failing to Monitor Manipulative Trading

The Case

FINRA recently fined two broker-dealers for failing to adequately supervise and monitor trading activities to detect and prevent potentially manipulative practices. 

The firms relied on third-party automated surveillance systems that were not properly configured, leading to multiple regulatory violations. These deficiencies included:

• Narrow Surveillance Parameters: The firms’ surveillance systems were configured with overly restrictive criteria, failing to capture manipulative trades occurring over longer periods or with varying volumes and prices.
  
  

• Exclusion of Certain Securities: Certain securities, such as over-the-counter (OTC) securities and warrants, were excluded from oversight due to either a lack of required data feeds or coding errors.
  
  

• Unreviewed Alerts: The firms failed to review a substantial number of alerts for potentially manipulative trades, neglecting to investigate around 700 equity trades and 125,000 options trades flagged as suspicious.

FINRA determined that these failures violated FINRA Rules 2010 (Standards of Commercial Honor and Principles of Trade) and 3110 (Supervision). The firms agreed to a censure and a $3 million fine, and were required to undertake remediation efforts. Senior management must certify compliance within 180 days.

Regulatory Implications

FINRA’s enforcement action underscores the importance of maintaining effective surveillance systems to detect manipulative trading. 

While the standard is one of "reasonableness" rather than perfection, firms must document their rationale for their surveillance parameters, which they must periodically review and adjust to capture a broad range of potentially manipulative activities. The case also highlights the risks associated with relying on automated systems that are either improperly configured or not regularly monitored for changes.

Firms must set up surveillance systems with the flexibility to detect a wide variety of manipulative behaviors, such as wash trading, spoofing, and layering, across all relevant securities, including OTC and warrants. 

Additionally, firms should promptly investigate all alerts and maintain a process to review and adjust surveillance practices in response to changing trading patterns or regulatory risks.

Practical Guidance for Firms

To avoid similar enforcement actions, broker-dealers should take the following steps:

• Review and Update Surveillance Parameters: Firms should regularly test and update their surveillance parameters to ensure they cover a broad range of potentially manipulative trading behaviors. Testing should include experimenting with different parameters and documenting the results, especially regarding false positives.
  
  

• Expand Surveillance to All Securities: All securities, including OTC and warrants, must be included in the surveillance scope and be reviewed periodically.
  
  

• Ensure Timely Review of Alerts: Establish a process to monitor and review alerts on a timely basis.
  
  

• Document the Decision-Making Process: Firms should document the steps taken to determine their surveillance routines, including the rationale behind parameter settings and any changes. 

InnReg offers expert compliance services to help broker-dealers establish robust surveillance systems and documentation processes.

Our team assists in reviewing, testing, and enhancing surveillance parameters to align with FINRA’s expectations and industry best practices.