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Ensuring Regulatory Compliance Includes Detecting Questionable Order Activity

“Spoofing” is a trading practice involving the placement of non-bona fide orders and subsequent cancellation for the purpose of manipulating market conditions. “Layering” is a related practice where orders are placed on a certain side of the side of the market at incremental price levels to create the impression of buying or selling volume. Both order-based manipulative practices were formally addressed under the sweeping 2010 Dodd-Frank Act financial legislation. It wasn’t until 2016 that an individual was criminally prosecuted and sentenced under the 2010 Act.

In 2016, Michael Coscia of Panther Energy Trading received a three-year sentence related to an algorithmic fake order flow. The case marks a regulatory maturation where order-based market manipulation can and will be pursued to the fullest extent. Dodd-Frank, along with landmark European regulations MAR and MiFID II, elevates standards and expands scope of market surveillance obligations. They carve a more aggressive path for legal and regulatory action.

Regulation has shifted focus from transactional-based monitoring to trending and patterned based problem solving. As a result, securities firms need to go beyond just monitoring executed trades to account for order activity.

“Order behavior has been more difficult to consider historically, but manipulative orders play just as much a part, if not more, in distorting markets. A market surveillance system absolutely needs to account for it,” says Scott Burke, Surveillance Subject Matter Expert at RIMES Technologies. “Regulators have increasingly demonstrated the ability to trace order intent. They have advanced their surveillance capability to detect problematic order patterns. Surveillance has traditionally been focused on surveillance of executed trades, but to exclude order behavior is to miss the big picture and fall short of your regulatory obligations.”

A set of models that consider all firm activity, both orders and trades, in the context of the market, as well as concise list management of insiders and securities are the key elements to a effective surveillance system, according to Burke. The underlying theme for successful monitoring is integration, so that they work together to flag problematic behavior.

Overlaying order and trading behavior with insider and restricted list information is critical for identifying potential use of materially non-public information (MNPI), another root motivation of suspicious order and trade behavior. The process at a firm to do this is typically disjointed and the production of reports is manually intensive. The evolution of regulation requires process automation and information cohesiveness; Compliance needs to connect the dots quickly and evidence they’ve done so. Additionally, a firm’s surveillance system must generate alerts based suspicious order behavior around MNPI, particularly when such behavior violates a firm’s own specific business-line policies.

RIMES RegFocus Market Surveillance models help clients consider their orders in conjunction with trades and in the context of the market. The system’s workflow capability gives a firm the ability to profile its behavior and efficiently evidence it is executing an appropriate compliance program.

“We manage and understand our clients’ data and have been for 20+ years; it’s who we are and what we do. Hosting a nimble, cloud-based surveillance solution to service client compliance is a natural place for our product,” says Burke. “Being cloud-based allows for smooth deployment as opposed to the challenge of fitting into a static, out-of-the box solution. This positions a client to build an integrated, holistic compliance environment without disruption.”

How confident are you that your current systems and processes are equipped to meet the elevated standards and expanded scope of market surveillance obligations? Contact RIMES for a consultation, or learn more at www.rimes.com/solutions/regtech-solutions/regfocus-market-surveillance/

The content provided in these articles is intended solely for general information purposes, and is provided with the understanding that the authors and publishers are not herein engaged in rendering regulatory or other professional advice or services. Consequently, any use of this information should be done only in consultation with qualified legal counsel. The information in these articles was posted with reasonable care and attention. However, it is possible that some information in these articles is incomplete, incorrect, or inapplicable to particular circumstances or conditions. We do not accept liability for direct or indirect losses resulting from using, relying or acting upon information in these articles.

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