HFTs to Register with FINRA

The SEC voted to amend Rule 15b9-1 on Wednesday in a move designed to bring more oversight to High Frequency Trading firms. We've blogged previously about bringing oversight to HFTs (more general detail regarding HFTs can be found in our White Paper here), and this appears to be the first step in that process.

HFT firms currently rely on an exemption from registration as broker-dealers within the Securities Exchange Act of 1934. The exemption provided by 15b9-1 was originally intended to allow floor-traders to hedge their own accounts, without requiring that they register as broker-dealers with a self-regulatory organization (SRO) under 15(b)(8). Historically, this was a sensible exemption as floor-based exchanges were in a good position to monitor the trading activity of their members, and it made little sense to require registration simply because members conducted a minimal amount of business (presumably hedging their own accounts) off of the exchange. However, this exemption creates a hole that HFTs are able to use today in order to avoid registration while trading their proprietary accounts.

Implementation of the proposed rule change will make HFT trading activity easier to monitor by forcing firms to register with FINRA. HFT activity (especially cross-market trading) would be captured by FINRA, with all parties involved identified. That would help FINRA to more easily identify instances of various forms of market abuse, as well as to hold parties responsible for their abusive conduct.

While the proposal received unanimous support from all SEC Commissioners, a number of them issued public statements pointing out potential weaknesses with the planned rule. Commissioner Aguilar pointed out that while the new rule creates a more limited exemption for hedging activity by floor-traders, the SEC has no data about those activities currently, and therefore may be misspecifying the planned exemption. These concerns were echoed by Commissioner Stein, and also by Commissioner Piwowar, who pointed out that the rule change created a situation in which firms would be forced to join FINRA, as the de facto SRO available, thereby enriching a private organization through increased fees. The issue of guiding more registrants towards FINRA was also pointed out by Commissioner Gallagher who noted that this change would also create additional oversight costs for broker-dealers, in a marketplace for broker-dealers that is already highly regulated. He cautioned strongly that "...we should not treat FINRA as the SEC’s deputy federal regulator" in addressing problems related to overseeing HFTs.

Market participants will have an opportunity to provide perspective on the Commissioners' concerns during a 60-day comment period that will commence after the proposed rule appears in the Federal Register.