The Financial Industry Regulatory Authority will examine how well high-frequency trading firms are protecting their systems from unscrupulous traders who are trying to manipulate markets, according to a list of its 2016 examination priorities for Wall Street firms, published on Tuesday.
High-frequency trading is an automated strategy that can move billions of dollars worth of trades in a fraction of a second.
FINRA's heightened focus on controls in place at high-frequency trading firms coincides with the growing prevalence of a new and more complex form of spoofing, a type of manipulation that involves faking orders for a security to deceive the market by creating the illusion of demand, said Richard Ketchum, FINRA's chairman and chief executive, in an interview.
The regulator is observing more instances in which traders are using multiple firms to place those orders, Ketchum said. The strategy can make the conduct trickier to track.
Spoofing occurs when traders place orders in markets without intending to execute them. The traders immediately cancel the orders, but other market participants mistakenly believe the price of the security has moved.
In the newer, more sophisticated type of spoofing, the traders then use yet another firm to buy or sell the security at issue after they have successfully tricked the market, Ketchum said, which allows the traders to attain their target price.
The watchdog said it would also examine the "firm culture" at Wall Street brokerages.
FINRA is concerned about how brokerages take actions to promote fair and ethical treatment of customers and help mitigate conflicts of interest, the watchdog said in its "2016 examination of U.S. brokerages."
The regulator said it would mainly assess five indicators of a firm's culture and the role they play in the way brokerages conduct business.
The indicators include the handling of policy or control breaches and of departments or trading desks that might not conform to the corporate culture, and the role of senior executives in a firm's culture.
"We’re not about suggesting whether there’s a single pass-fail as to whether a firm has a certain culture," Ketchum said. "It’s whether they comply with FINRA rules."
To that end, the regulator wants to understand how each firm's culture affects compliance and risk management practices.
FINRA also said it would look at the risks shouldered by trading firms who act as middlemen between exchange-traded fund issuers and public financial markets.
The regulator said it plans to make sure those short-term institutional investors – known formally as authorized participants – are properly measuring and monitoring the risk that they might not be able to instantly redeem ETFs for the stocks, bonds or other securities held by the fund. Such authorized participants are essential to ETFs because ordinary investors cannot directly redeem ETFs with fund issuers.
FINRA routinely examines the industry's more than 4,100 securities firms to gauge their compliance with securities industry rules.
(Reporting by Suzanne Barlyn and Ankit Ajmera; Additional reporting by Trevor Hunnicutt; Editing by Andrea Ricci)
By Suzanne Barlyn and Ankit Ajmera
