On April 7, 2016, the Securities and Exchange Commission (SEC) approved a proposed rule change by the Financial Industry Regulatory Authority (FINRA) that requires registration as Securities Traders of associated persons of FINRA members that are primarily responsible for the design, development or significant modification of algorithmic trading strategies. Securities Exchange Act of 1934 Release No. 77551, 81 FR 21914 (April 13, 2016). Associated persons who are responsible for the day-to-day supervision or direction of such activities would also be required to register. Associated persons falling under the expanded rule will be required to pass the requisite qualifications examination and will be subject to applicable continuing education requirements.
Under the approved rule change, FINRA defines an “algorithmic trading strategy” as an automated system that generates or routes orders or order-related messages—such as routes or cancellations—but does not include an automated system that solely routes orders received in their entirety to a market center. An algorithm that solely generates trading ideas or investment allocations, but that is not equipped to automatically generate orders and order-related messages to effect such trading ideas into the market—whether independently or via a linked router—would not constitute an algorithmic trading strategy.
FINRA notes that a member employing an algorithm is responsible for the algorithm’s activities whether the algorithm is designed or developed in-house or by a third party. In cases where a FINRA member contracts with a third party to develop an algorithmic trading strategy, associated persons of the FINRA member may still have registration requirements under the expanded rule. Firms are likely to have questions regarding what exactly constitutes an algorithmic trading strategy and which personnel of a FINRA member are required to register, particularly where the algorithm is developed by a third party.
These registration requirements follow not long after FINRA’s Regulatory Notice regarding Supervision and Control Practices for Algorithmic Trading Strategies, see FINRA Regulatory Notice 15-09, and coincide with additional initiatives by the SEC to “improve firms’ risk management of trading algorithms and to enhance regulatory oversight over their use.” See Mary Jo White, Chair, Commission, Enhancing our Equity Market Structure, Speech at the Sandler, O’Neill & Partners, L.P. Global Exchange and Brokerage Conference (June 5, 2014). The collective initiatives signal that firms’ use of algorithms continues to grow as an increasingly important area of regulatory and enforcement focus.
FINRA will announce the effective date of the proposed rule change in a Regulatory Notice to be published no later than June 6, 2016, and the effective date will be no sooner than 180 days following publication of the Regulatory Notice, but no later than 300 days following Commission approval (February 1, 2017).