March 21, 2014
High Frequency Trading or HFT has been in the headlines lately, and along with that scrutiny, we're also seeing a bit of unease among the so-called day-trading community. It's not that HFT and day trading necessarily go hand in hand -- in fact, HFT tends to be far more of a well funded, sophisticated high-tech undertaking these days, whereas day trading is often the realm of in-and-out traders sitting transfixed before their online trading screens. In some sense, it's a colocated server farm versus a laptop situated on a desk in the family room. It's computerized algorithms versus the last of the human traders. No matter how you view it, you still got lots of trading trying to pick off a few pennies on massive amounts of volume.
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Mitchell Garrett submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Mitchell Garrett, Respondent (AWC 2010023935003, March 13, 2014).
Garrett was first registered in 2004 and by July 2010, he was registered with FINRA member firm Lightspeed Trading, LLC, where he remained until June 28, 2012.
Unregistered Day Trading Firm
During the time that Garrett was registered with FINRA member firm Lightspeed, he was also affiliated with an unregistered day-trading firm. The AWC asserts that the unregistered day-trading firm "recruited retail customers to open accounts with Lightspeed to trade securities using the day-trading firm's offices and equipment." The day trading customers were charged commissions by Lightspeed, a portion of which were paid monthly to Garrett as the registered representative of record.
The Commission Run
The AWC alleges that Garrett paid all of the roughly $145,142 in his Lightspeed commissions to the unregistered day-trading firm, which distributed those payments to its three owners, each of whom was not a registered person at a FINRA member firm. The AWC clarifies that Garrett was not an owner of the day-trading firm, and he did not retain any of the Lightspeed commissions for himself. The AWC does, however, assert that an "indeterminate portion of the commissions that Garrett paid the owners of the day-trading firm represented rent from Garrett for his use of the day-trading firm's office and equipment."
Whack A Mole
At first glance it may come off as a nice, tightly wrapped package, but there's a mole whose head is sticking up out of a hole. And if there's one thing that regulators enjoy, it's a game of whack-a-mole. Here's the thing that sticks out: Garrett earned something like $145,142 in commissions at Lightspeed but he seems to have handed virtually all of that amount to the three owners of the day trading firm.
Ah, now there's an intriguing question and likely the very same one that FINRA asked.
The answer apparently provided to FINRA was that Garrett's Lightspeed commissions just about equaled the rent that the day trading firm was charging Garrett for use of an office and equipment.
My, how convenient and, geez, how unfortunate for the registered person that his commissions evaporated into rental payments. For FINRA, the issue probably evolved into whether the commissions paid to Garrett were meant to compensate him for his role as the registered representative at Lightspeed; or whether, the payments were some form of subterfuge intended to disguise payments to the unregistered firm.
Going To The Rulebook
Let's take a gander at a particular FINRA rule that probably came up during the SRO's review of Garrett's activity.
NASD Business Conduct Rule 2420. Dealing with Non-Members
(a) No member shall deal with any non-member broker or dealer except at the same prices, for the same commissions or fees, and on the same terms and conditions as are by such member accorded to the general public.
(b) Without limiting the generality of the foregoing, no member shall:
(1) in any transaction with any non-member broker or dealer, allow or grant to such non-member broker or dealer any selling concession, discount or other allowance allowed by such member to a member of a registered securities association and not allowed to a member of the general public;
(2) join with any non-member broker or dealer in any syndicate or group contemplating the distribution to the public of any issue of securities or any part thereof; or
(3) sell any security to or buy any security from any non-member broker or dealer except at the same price at which at the time of such transaction such member would buy or sell such security, as the case may be, from or to a person who is a member of the general public not engaged in the investment banking or securities business.
(c) Transaction with Foreign Non-Members
The provisions of paragraphs (a) and (b) of this Rule shall not apply to any non-member broker or dealer in a foreign country who is not eligible for membership in a registered securities association, but in any transaction with any such foreign non-member broker or dealer, where a selling concession, discount, or other allowance is allowed, a member shall as a condition of such transaction secure from such foreign broker or dealer an agreement that, in making any sales to purchasers within the United States of securities acquired as a result of such transactions, he will conform to the provisions of paragraphs (a) and (b) of this Rule to the same extent as though he were a member of the Association.
(d) "Non-Member Broker or Dealer"
For the purpose of this Rule, the term "non-member broker or dealer" shall include any broker or dealer who makes use of the mails or of any means or instrumentality of interstate commerce to effect any transaction in, or to induce the purchase or sale of, any security, otherwise than on a national securities exchange, who is not a member of any securities association registered with the Commission pursuant to Section 15A of the Act, except a broker or dealer who deals exclusively in commercial paper, bankers' acceptances or commercial bills.
(e) Nothing in this Rule shall be so construed or applied as to prevent any member of the Association from granting to any other member of any registered securities association any dealer's discount, allowance, commission, or special terms.
FINRA apparently wasn't buying the explanation that the commissions were being paid as "rent." More to the point, FINRA deemed the purported rent as nothing more than the sharing of commission with unregistered persons by Garrett in violation of NASD Rule 2420 and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon Garrett:
- a 30-business-day suspension in all capacities from associating with any FINRA member firm.
- a $10,000 fine; and
- an undertaking to cooperate with FINRA's Department of Enforcement staff in its continuing investigation of matter no. 20100239350, including the prosecution of these matters before a FINRA hearing panel, by, among other things, meeting with and being interviewed by the staff without FINRA's resorting to Rule 8210, and testifying truthfully at the hearing of any disciplinary actions arising from the matters.
Solely going by this AWC, it appears that -- at least for now -- FINRA has determined that Garrett was the bad guy here because he shared commissions with unregistered persons (presumably the owners of the unregistered day trading firm). What isn't satisfactorily addressed is why Garrett would willingly hand over six-figures in commissions to a day trading firm in which he lacked an ownership interest. Clearly, something here is not adding up -- which may well explain the "undertaking to cooperate . . . [in] any disciplinary actions arising from the matters."