On October 20, Carlo di Florio, chief risk officer and head of strategy of the Financial Industry Regulatory Authority, gave a speech at the National Society of Compliance Professionals regarding risk and regulatory issues in the markets and FINRA’s risk-based exam program, Comprehensive Automated Risk Data System (CARDS), the Consolidated Audit Trail (CAT) and FINRA’s efforts to improve transparency. 

Mr. di Florio cited algorithmic trading malfunctions that caused substantial market disruptions in recent years and said that FINRA and the Securities and Exchange Commission are focused on assessing whether firms’ testing and controls related to high-frequency trading and other algorithmic trading strategies and trading systems are adequate. Mr. di Florio cautioned firms “to be prepared to address whether they conduct separate, independent, and robust pre-implementation testing of algorithms and trading systems.” 

Mr. di Florio mentioned that FINRA’s board last month approved a proposal, for which FINRA will soon seek comment, that would require those who design, develop or direct the significant modification of an algorithmic strategy, and those who supervise such persons, to register with FINRA. FINRA will also publish guidance reminding firms of their existing supervisory obligations with regard to the development and deployment of algorithmic trading strategies and provide additional guidance to firms on effective controls and practices to monitor for and prevent potential adverse impacts on the market. The guidance will also cover firms’ obligations in these areas, and supervision and control practices for firms and market participants that use algorithmic trading strategies. 

Mr. di Florio said that FINRA and the SEC believe that more oversight is needed for dark pools, high-frequency trading and algorithmic trading and mentioned that FINRA’s board last month approved a proposal for FINRA to publish volume information on equity securities in the over-the-counter market that is reported to FINRA’s equity trade reporting facilities to be available for non-industry professionals. 

With respect to cross-market surveillance, Mr. di Florio said that FINRA’s initiative to implement CAT will enable it to collect, identify and link every customer order, cancellation, modification and trade execution for all exchange-listed equities, options and fixed income products across all US markets. With respect to CARDS, Mr. di Florio said that CARDS will allow FINRA to collect information in a standardized format across all firms on a regular basis and that the information that FINRA would collect through CARDS is substantially consistent with the information collected through exams. Mr. di Florio added that CARDS will help FINRA better understand the business profile of a firm and incorporate that understanding into FINRA’s examination, surveillance, cycle planning and risk-assessment functions.  

Mr. di Florio concluded the speech by discussing how firms should address conflicts of interest. Mr. di Florio said that FINRA believes an effective conflicts management framework should address the following considerations:

  • establishing new product review processes that include perspectives independent from the business proposing products, that identify potential conflicts raised by new products, that restrict distribution of products that may pose conflicts that cannot be effectively mitigated and that periodically re-assesses products through post-launch reviews;
  • making independent decisions in the wealth management business about the products offered without pressure to favor proprietary products or products for which the firm has revenue-sharing agreements;
  • minimizing conflicts in compensation structures between customer and broker or firm interests where possible and including heightened supervision when conflicts remain; for example, around thresholds in a firm’s compensation structure;
  • mitigating conflicts of interest through disclosures and other information that enables customers to understand the factors that may affect a product’s financial outcome—such as the use of scenarios and graphics for a particular product; and
  • including “best-interest-of-the-customer” standards in codes of conduct that apply to brokers’ personalized recommendations to retail customers in order to maintain and increase investor trust. 

Click here for the full text of Mr. di Florio’s speech.