[Federal Register Volume 79, Number 88 (Wednesday, May 7, 2014)]
[Notices]
[Pages 26293-26297]
[FR Doc No: 2014-10384]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72067; File No. SR-FINRA-2013-036]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving Proposed Rule Change, as Modified by
Amendment No. 1, Relating to Self-Trades and FINRA Rule 5210
(Publication of Transactions and Quotations) May 1, 2014.

I. Introduction

    On August 15, 2013, the Financial Industry Regulatory Authority,
Inc. (``FINRA'') filed with the Securities and Exchange Commission (the
``Commission'') pursuant to Section 19(b)(1) of the Securities Exchange
Act of 1934 (the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed
rule change to add Supplementary Material .02 to FINRA Rule 5210
(Publication of Transactions and Quotations) to emphasize that wash
sale transactions are generally non-bona fide transactions and that
members have an obligation to have policies and procedures in place to
review their trading activity for, and prevent, wash sale transactions.
The proposed rule change was published for comment in the Federal
Register on September 4, 2013.\3\ The Commission

received five comment letters on the proposed rule change.\4\ On
October 4, 2013, the Commission extended the time period for Commission
action to December 3, 2013.\5\ On December 2, 2013, FINRA submitted a
response to the comment letters \6\ and filed Amendment No. 1 to the
proposed rule change. On December 3, 2013, the Commission published for
comment both Amendment No. 1 and an order instituting proceedings under
Section 19(b)(2)(B) of the Act \7\ to determine whether to approve or
disapprove the proposed rule change, as modified by Amendment No. 1.\8\
The Commission received three comment letters on the Notice of Filing
of Amendment No. 1 and Order Instituting Proceedings.\9\ On February
24, 2014, FINRA submitted a response to the comment letters.\10\ This
order approves the proposed rule change, as modified by Amendment No.
1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 70276 (August 28,
2013), 78 FR 54502 (``Notice'').
    \4\ See letter from Anonymous to Elizabeth M. Murphy, Secretary,
Commission, dated September 9, 2013 (``Anonymous Letter''); letter
from William A. Jacobson, Clinical Professor of Law, and Director,
Cornell Securities Law Clinic, and Jimin Lee, Cornell University Law
School, to Elizabeth M. Murphy, Secretary, Commission, dated
September 25, 2013 (``Cornell Letter''); letter from Stuart J.
Kaswell, Executive Vice President, Managing Director and General
Counsel, Managed Funds Association, to Elizabeth M. Murphy,
Secretary, Commission, dated September 25, 2013 (``MFA Letter'');
letter from Manisha Kimmel, Executive Director, Financial Industry
Forum, to Elizabeth M. Murphy, Secretary, Commission, dated
September 25, 2013 (``FIF Letter''); and letter from Theodore R.
Lazo, Managing Director and Associate General Counsel, Securities
Industry and Financial Markets Association, to Elizabeth M. Murphy,
Secretary, Commission, dated October 4, 2013 (``SIFMA Letter''). For
a discussion of these comment letters, see Notice of Filing of
Amendment No. 1 and Order Instituting Proceedings, infra note 8, at
73902-73903.
    \5\ See Securities Exchange Act Release No. 70613 (October 4,
2013), 78 FR 62784 (October 22, 2013).
    \6\ See letter from Brant K. Brown, Associate General Counsel,
FINRA, to Elizabeth M. Murphy, Secretary, Commission, dated December
2, 2013 (``FINRA Response 1'').
    \7\ 15 U.S.C. 78s(b)(2)(B).
    \8\ See Securities Exchange Act Release No. 70966 (December 3,
2013), 78 FR 73900 (December 9, 2013) (``Notice of Filing of
Amendment No. 1 and Order Instituting Proceedings'').
    \9\ See letter from Manisha Kimmel, Executive Director,
Financial Industry Forum, to Elizabeth M. Murphy, Secretary,
Commission, dated December 23, 2013 (``FIF Letter 2''); letter from
Mary Ann Burns, Chief Operating Officer, Futures Industry
Association, to Elizabeth M. Murphy, Secretary, Commission, dated
January 6, 2014 (``FIA PTG Letter''); and letter from Theodore R.
Lazo, Managing Director and Associate General Counsel, Securities
Industry and Financial Markets Association, to Elizabeth M. Murphy,
Secretary, Commission, dated January 13, 2014 (`SIFMA Letter 2'').
    \10\ See letter from Brant K. Brown, Associate General Counsel,
FINRA, to Elizabeth M. Murphy, Secretary, Commission, dated February
24, 2014 (``FINRA Response 2'').
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II. Description of the Proposal, as Modified by Amendment No. 1

    FINRA proposes to add Supplementary Material .02 to FINRA Rule 5210
to address members' obligations with respect to certain securities
transactions that result from the unintentional interaction of orders
originating from the same firm (now referred to by FINRA as ``self-
trades''), that involve no change in the beneficial ownership of the
security.\11\ The proposed rule change requires FINRA members to have
policies and procedures in place that are reasonably designed to review
their trading activity for, and prevent, a pattern or practice of self-
trades resulting from orders originating from a single algorithm or
trading desk, or from related algorithms or trading desks.
Additionally, the proposed rule change states that transactions
resulting from orders that originate from unrelated algorithms or from
separate and distinct trading strategies within the same firm would
generally be considered bona fide self-trades.\12\ The proposed rule
change also establishes a presumption that algorithms or trading
strategies within the most discrete unit of an effective system of
internal controls at a member firm are related.
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    \11\ Securities transactions that do not result in a change of
beneficial ownership of the securities and that are undertaken for
the purpose of creating or inducing a false or misleading appearance
of activity in the securities are already prohibited by existing
securities laws and FINRA rules. See note 14, infra.
    The Commission notes that the original proposal addressed wash
sale transactions. Subsequently, FINRA filed Amendment No. 1, which
clarified that the focus of the proposal was self-trades, rather
than wash sale transactions.
    \12\ Transactions that originate from unrelated algorithms or
from separate or distinct trading strategies, trading desks, or
aggregation units that are frequent or numerous may raise a
presumption that such transactions were undertaken with the intent
that they cross and may, therefore, be intended as manipulative or
fraudulent. See Notice, supra note 3, at 54503.
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    The proposed rule change is intended to address self-trades that
occur as a result of orders sent by a single algorithm or the
interaction of multiple, related algorithms operated by a single firm.
In a number of instances, FINRA has found that these types of
transactions can account for a material percentage (e.g., over 5%) of
the consolidated trading volume in a security on a particular day,
which can distort the market information that is publicly available for
that security. In FINRA's view, even if not purposeful, these
transactions can create the misimpression of active trading in a
security that could adversely affect the price discovery process.
Furthermore, FINRA believes that, in these instances, firms will
continue to allow this type of trading to occur rather than incur the
costs necessary to prevent it, even though the trading activity may
result in instances where significant misinformation is disseminated to
the market. The proposed rule change requires members to adopt
reasonable policies and procedures to prohibit such activity and would
not, therefore, apply to isolated self-trades resulting from orders
originating from a single algorithm or trading desk, or from related
algorithms or trading desks, provided the firm's policies and
procedures were reasonably designed.\13\
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    \13\ The proposed rule change would not change member firms'
existing obligations under NASD Rule 3010 and FINRA Rule 2010 with
respect to wash sales. See Notice, supra note 3, at 54503.
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    FINRA rules and the federal securities laws explicitly prohibit
transactions in securities that do not result in a change of beneficial
ownership of the securities when there is a fraudulent or manipulative
purpose behind the trading activity.\14\ In addition, FINRA Rule 5210
provides that no member may cause to be published or circulated any
report of a securities transaction unless the member knows or has
reason to believe that the transaction was a bona fide transaction.
Supplementary Material .01 states that ``[i]t shall be deemed
inconsistent with Rules 2010 (Standards of Commercial Honor and
Principles of Trade), 2020 (Use of Manipulative, Deceptive or Other
Fraudulent Devices) and 5210 (Publication of Transactions and
Quotations) for a member to publish or circulate or cause to be
published or circulated, by any means whatsoever, any report of any
securities transaction or of any purchase or sale of any security
unless such member knows or has reason to believe that such transaction
was a bona fide transaction, purchase or sale.'' Thus, each FINRA
member has an existing obligation to know, or have a basis to believe,
that transactions in which it participates are bona fide.
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    \14\ See, e.g., 15 U.S.C. 78i(a)(1); FINRA Rule 6140(b).
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III. Discussion and Commission Findings

    The Commission has carefully considered the proposal, the comments
submitted, and FINRA's response to the comments, and believes that
FINRA has responded adequately to the concerns raised by the commenters
and by the Commission in the Order Instituting Proceedings. For the
reasons discussed below, the Commission finds that the proposal is
consistent with the

requirements of the Act and the rules and regulations thereunder
applicable to a national securities association.\15\ In particular, the
Commission finds that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\16\ which requires, among
other things, that FINRA's rules be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. The proposal requires firms to adopt policies and
procedures reasonably designed to prevent a pattern or practice of
certain types of self-trades, which could create the misimpression of
active trading and adversely affect the price discovery process. Thus,
the proposed rule change is designed to improve the quality of
transaction information that is disseminated to the public.
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    \15\ In approving the proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition and
capital formation. See 15 U.S.C. 78c(f).
    \16\ 15 U.S.C. 78o-3(b)(6).
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    As noted above, the Commission received three comment letters in
response to the Notice of Filing of Amendment No. 1 and Order
Instituting Proceedings \17\ and FINRA responded to the comments.\18\
Two comment letters supported the approval of the proposed rule change,
as amended.\19\ The third comment letter is generally supportive, but
requests modifications to the proposal.\20\
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    \17\ See FIF Letter 2; FIA PTG Letter; SIFMA Letter 2, supra
note 9. For a discussion of the comment letters received by the
Commission in response to the Notice, see Notice of Filing of
Amendment No. 1 and Order Instituting Proceedings, supra note 8, at
73902-73903.
    \18\ See FINRA Response 2, supra note 10.
    \19\ See FIF Letter 2; SIFMA Letter 2, supra note 9.
    \20\ See FIA PTG Letter, supra note 9.
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    Two commenters support FINRA's amendment to focus the proposed rule
change on ``self-trades,'' rather than ``wash sales.'' \21\ One
commenter supports FINRA's replacement of the term ``wash sale'' with
``self-trade,'' explaining that, unlike wash sale transactions, self-
trades can be inadvertent and bona fide.\22\ The commenter believes
that this change in terminology recognizes that automated trading can
result in coincidental self-trades from independently initiated orders
that lack the requisite fraudulent or manipulative intent to be
classified as ``wash sales.'' \23\ The other commenter also supports
the distinction and states that the proposed rule better addresses the
concern raised in the original proposal--that self-trades can distort
market information regarding a security--by creating an obligation for
broker-dealers to avoid transactions that unintentionally result in no
change in beneficial ownership and do not involve manipulative or
fraudulent intent.\24\
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    \21\ See FIA PTG Letter, supra note 9, at 2; SIFMA Letter 2,
supra note 9, at 1.
    \22\ See FIA PTG Letter, supra note 9, at 2.
    \23\ Id.
    \24\ See SIFMA Letter 2, supra note 9, at 1-2.
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    Because the proposal is intended to address the unintentional
interaction of orders originating from the same firm that involve no
change in the beneficial ownership of the security and can lead to the
dissemination of misinformation to the marketplace and the public, the
Commission believes that modifying the focus of the proposed rule from
``wash sales'' to ``self-trades'' appropriately tailors the scope of
the proposed rule and addresses potential confusion.
    Two commenters support FINRA's requirement that members have
policies and procedures in place to review their trading activity for,
and prevent, a pattern or practice of self-trades resulting from orders
originating from a single algorithm or trading desk, or related
algorithms or trading desks.\25\ One commenter states, ``Amendment No.
1 strikes the right balance of addressing a pattern and [sic] practice
of self-trading while acknowledging the implementation issues inherent
in preventing every self-trade.'' \26\ This commenter believes that the
pattern or practice standard addresses the problem outlined in the
proposal of self-trades that distort the market information that is
publicly available for a security.\27\ The other commenter believes
that the pattern or practice standard would deter broker-dealers from
permitting large numbers of self-trades from being publicly
reported.\28\
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    \25\ See FIF Letter 2, supra note 9, at 1-2; SIFMA Letter 2,
supra note 9, at 2. FIA PTG also supports FINRA's amended policies
and procedures requirement, but believes the requirement needs to be
clarified. See FIA PTG Letter, supra note 9, at 2, 7.
    \26\ See FIF Letter 2, supra note 9, at 1.
    \27\ See FIF Letter 2, at 2, supra note 9.
    \28\ See SIFMA Letter 2, supra note 9, at 2.
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    In its response, FINRA explains that the proposed supplementary
material is primarily designed to address instances where self-trades
account for a significant percent of volume in a security, which may
affect price discovery.\29\ FINRA explains that its proposed policies
and procedures requirement addresses its concern that self-trades by a
single algorithm or trading desk, or related algorithms or trading
desks, may not reflect genuine trading interest, especially when there
is a pattern or practice of such trading behavior.\30\ FINRA believes
that its proposal will allow FINRA to more effectively deter self-
trading that, while not involving fraudulent or manipulative intent, is
disruptive to the marketplace.\31\
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    \29\ See FINRA Response 2, supra note 10, at 3.
    \30\ Id.
    \31\ Id.
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    Tailoring the limitation in the supplementary material to a pattern
or practice of self-trades resulting from orders originating from a
single algorithm or trading desk, or related algorithms or trading
desks, would not prohibit isolated instances of self-trading, yet would
address more systematic self-trading that could result in the
dissemination of misleading trading information to the marketplace. The
proposal would provide FINRA with an enforceable rule specifically
targeting activity that rises to the level of a pattern or practice of
such self-trading, and requires firms to have policies and procedures
reasonably designed to review their trading activity for, and prevent,
the same. The Commission encourages FINRA to surveil the efficacy of
these policies and procedures in reducing the volume of self-trading,
and to consider further refinement of the rule if warranted.
    One commenter requests that FINRA clarify its distinction between
bona fide and non-bona fide self-trades.\32\ This commenter notes that
the proposed rule states that self-trades that result from orders
originating from unrelated algorithms or separate and distinct trading
strategies within the same firm are generally bona fide, but that FINRA
also stated in the Notice that such transactions, if frequent or
regular, may raise a presumption of manipulative or fraudulent
intent.\33\ The commenter requests clarification of FINRA's views on
frequent self-trades resulting from unrelated trading strategies, and
asserts that it would be ``inappropriate and inaccurate to infer their
relatedness or the intent to self-trade based solely on a volume
threshold.'' \34\ Instead, the commenter recommends that FINRA adopt a
wash sale approach described by the Chicago Mercantile Exchange Group
(``CME'') in a recent CME Market Regulation Advisory Notice to
determine whether trades between unrelated algorithms are bona
fide.\35\ The commenter explains that the CME Market Regulation
Advisory Notice states that orders entered by an independent trader in
good faith for the purpose of executing bona fide

transactions, that are not prearranged and are entered without
knowledge of the other trader's order, will not violate the CME's
prohibition on wash trades.\36\ Similarly, another commenter requests
that FINRA issue a Regulatory Notice that states that self-trades
resulting from orders originating from unrelated algorithms would not
be deemed related based solely on the fact that the unrelated
algorithms were being used by traders on the same trading desk.\37\
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    \32\ See FIA PTG Letter, supra note 9, at 3-4.
    \33\ Id.
    \34\ Id. at 4.
    \35\ Id.
    \36\ Id. In its comment letter, FIF noted that it believes that
FINRA's pattern and practices standard is consistent with the
guidance provided in the CME Market Regulation Advisory Notice. See
FIF Letter 2, supra note 9, at 2.
    \37\ See FIF Letter 2, supra note 9, at 2.
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    In its response, FINRA reiterates its position that, although self-
trades between unrelated trading desks or algorithms are generally bona
fide, frequent self-trades may raise concerns that they are intentional
or undertaken with manipulative or fraudulent intent.\38\ FINRA also
distinguishes its proposal's goals from those addressed by the CME
Market Regulation Advisory Notice.\39\ FINRA notes that its proposal is
meant to address unintentional self-trading activity--not the
regulation of wash sale transactions.\40\ Further, unlike the CME
Market Regulation Advisory Notice, FINRA states that its proposal
``imposes specific additional obligations on firms that engage in
algorithmic activity or use multiple algorithms or trading desks as
part of their trading activity.'' \41\ The proposal is intended to curb
unintentional self-trades that result in the dissemination of
misinformation to the public and negatively affect price discovery.
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    \38\ See FINRA Response 2, supra note 10, at 4.
    \39\ Id.
    \40\ Id.
    \41\ Id.
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    One commenter states that FINRA's amended proposal would continue
to establish a rebuttable presumption that algorithms within discrete
units of a firm's internal controls are related, regardless of comments
that assert that ``discrete units of a firm's internal controls are
established for reasons wholly separate from whether the trading
strategies and algorithms within that unit are related.'' \42\ The
commenter believes that the proposal causes confusion over whether the
presumption can be overcome.\43\ The commenter requests that FINRA
provide clear guidance on the standards that would rebut the
presumption of relatedness.\44\ In its response, FINRA explains that
the presumption is based on the fact that generally firms have the same
people supervising algorithms or trading desks within a discrete unit,
and that such algorithms or trading desks communicate with each
other.\45\ FINRA states, however, that firms would be able to rebut
this presumption if they can show, for example, that different
personnel are responsible for supervising the algorithms or trading
desks.\46\ The Commission believes that FINRA has taken a reasonable
position with respect to this presumption and provided appropriate
guidance with respect to how it might be rebutted.
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    \42\ See FIA PTG Letter, supra note 9, at 5.
    \43\ Id., at 6.
    \44\ Id.
    \45\ See FINRA Response 2, supra note 10, at 4.
    \46\ Id.
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    One commenter believes that the proposed rule lacks clarity
regarding the types of self-trading for which firms would need to
review, and prevent, patterns or practices.\47\ The commenter requested
more specificity from FINRA about the amount of activity that would
constitute a pattern or practice.\48\ In response to the commenter,
FINRA states that it ``declines to establish a specific threshold below
which a firm could continue to engage in unlimited self-trading.'' \49\
FINRA reiterates that isolated self-trades are generally bona fide, but
that a practice of self-trading over time ``whether of material volume,
regularity, or both,'' would indicate a pattern or practice.\50\ The
Commission believes that the proposed rule change, as amended provides
sufficient clarity to member firms, and notes that the concept of a
pattern or practice is used in a number of FINRA rules.\51\
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    \47\ See FIA PTG Letter, supra note 9, at 7.
    \48\ Id.
    \49\ See FINRA Response 2, supra note 10, at 5.
    \50\ Id.
    \51\ See, e.g., FINRA Rule 6282, Supplementary Material .02(b).
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    In the Notice of Filing of Amendment No. 1 and Order Instituting
Proceedings, the Commission expressed concern that the proposed rule,
as amended, would continue to allow a significant number of self-trades
to be publicly reported.\52\ Specifically, the Commission noted FINRA's
statement in its filing that only those firms that engage in a pattern
or practice of effecting self-trades that result in a material
percentage of the trading volume in a particular security would
generally violate the proposed rule, as well as FINRA's proposed
requirement that its members have policies and procedures to prevent,
specifically, a pattern or practice of self-trades from orders
originating from a single or related algorithms or trading desks.\53\
The Commission stated that the proposed rule would appear to provide
substantial flexibility regarding the required policies and procedures,
such that a significant number of self-trades could continue to be
publicly reported, as orders originating from ``unrelated'' algorithms
or ``separate and distinct'' trading strategies would not be subject to
the proposed rule, and because only self-trades amounting to a material
percentage of a security's trading volume would constitute violative
activity.\54\ The Commission also noted that FINRA provided little
guidance on its interpretations of what would constitute ``unrelated''
algorithms or ``separate and distinct'' trading strategies.\55\
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    \52\ See Notice of Filing of Amendment No. 1 and Order
Instituting Proceedings, supra note 8, at 73904.
    \53\ Id.
    \54\ Id.
    \55\ Id.
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    In its response, FINRA explained that the proposed rule is designed
to strike a balance between recognizing that self-trades may reflect
genuine trading interest and therefore be bona fide, and imposing an
obligation on firms to prevent a pattern or practice of self-trading
that rises to the level of disruptive activity. While self-trades may
be unintentional, if the number of self-trades by a firm constitutes a
material percentage of the volume in a security, it could have a
negative effect on the price discovery process.\56\ FINRA explained
that the proposed rule would allow it to better pursue self-trading
violations because the proposed rule specifically addresses self-
trades, allowing FINRA to charge a firm with a violation of the
proposed rule for such conduct, in addition to a supervisory violation,
and establishing a new requirement for firms to monitor and prevent
self-trading activity from a single algorithm or trading desk, or
related algorithms or trading desks.\57\
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    \56\ See FINRA Response 2, supra note 10, at 2-3.
    \57\ Id.
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    In response to the concern about a lack of guidance on the types of
self-trades that would violate the proposed rule, FINRA stated its
understanding that discrete units within a firm's system of internal
controls typically do not coordinate their trading strategies or
objectives with other discrete units of internal controls, but that
multiple algorithms or trading desks within a discrete unit are
permitted to communicate or are under the supervision of the same
personnel and thus, are presumed to be related.\58\ FINRA stated that
the proposed rule permits firms to rebut this presumption, suggesting
that a firm could demonstrate

that ``related'' algorithms or trading desks are in fact independent or
are subject to supervision or management by separate personnel.\59\
FINRA declined to specify a volume of trading that would constitute a
``pattern or practice'' for purposes of the proposed rule, explaining
that it preferred not to ``establish a specific threshold below which a
firm could continue to engage in unlimited self-trading,'' \60\ but
urged firms to examine their self-trading for volume and frequency,
which could indicate a pattern or practice.\61\
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    \58\ Id. at 4.
    \59\ Id.
    \60\ Id. at 5.
    \61\ Id.
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    Finally, FINRA noted that wash sales will continue to be subject to
the same provisions in the federal securities laws and FINRA rules.\62\
The Commission believes that FINRA has sufficiently addressed the
Commission's concerns. For the reasons discussed above, the Commission
finds that the proposed rule change is consistent with the Act.
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    \62\ See FINRA Response 2, supra note 10, at 3.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\63\ that the proposed rule change (SR-FINRA-2013-036), as modified
by Amendment No. 1, be, and hereby is, approved.
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    \63\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\64\
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    \64\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-10384 Filed 5-6-14; 8:45 am]
BILLING CODE 8011-01-P