In an effort to keep pace with rapidly accelerating market technology, the Securities & Exchange Commission (“SEC”) has taken steps to expand oversight over high-frequency trading.  On March 25, 2015, the SEC unanimously approved a plan requiring that rapid-fire trading firms register with the Financial Industry Regulatory Authority (“FINRA”).

The SEC’s plan imposes greater oversight over proprietary-trading firms that have remained outside of FINRA’s watch in the past through a regulatory exemption contained in SEC Rule 15b9-1, 17 C.F.R. § 240.15b9-1, promulgated under the Securities Exchange Act of 1934, 15 U.S.C. § 78, et seq.  Under the current form of this rule, firms that are members of a national exchange, do not carry customer accounts, and have less than $1,000 in annual trading income are not required to register with FINRA.  However, income derived from transactions for the dealer’s own account with or through another registered broker or dealer is excluded from the $1,000 allowance.

To counter this loophole, the SEC intends to eliminate the $1,000 threshold altogether and replace it with narrower requirements for the exemption.  The more focused exemption would operate to exclude about 125 firms from its coverage, according to an estimate by industry insiders.  The SEC contemplates that the proposed amendments to Rule 15b9-1 would become effective 360 days after publication of the final rule in the Federal Register.  

Whereas trading was once dominated by floor-based stock exchanges that could readily monitor trading, much of today’s market action occurs via computer algorithms and cross-market proprietary trading.  The SEC and other market regulators have grown increasingly concerned that flawed algorithms or other technological glitches could wreak havoc in the markets or that designers could develop an algorithm that would intentionally manipulate the market or create unfair advantages for its user.  In recent years, regulators have been actively exploring measures to update surveillance to account for modern day, technology-driven trading.

All five SEC Commissioners, including Chairman Mary Jo White, voted in favor of the change.  Commissioner Luis Aguilar said, in prepared remarks Wednesday, that the plan is integral to enhancing FINRA’s trading surveillance program.  “This will ensure that these [high frequency traders] can be held responsible for any potential misconduct,” he said.

In light of this increased oversight, proprietary trading firms that will become subject to FINRA’s jurisdiction should evaluate their compliance programs and regulatory response functions to ready themselves for FINRA oversight, including periodic cycle examinations and any potential enforcement investigations.