An irreverent Wall Street Blog
As Time Goes By At FINRA And TradeStation
March 4, 2021
In recent weeks, the press has been awash with stories about payment for order flow. You've seen it pop up in all its sordid glory via revelations about so-called Zero Commission trading -- to which I respond: TANSTAAFL (there ain't no such thing as a free lunch). With all the faux sincerity of Captain Renault, Wall Street's regulators are now blowing the whistle on crap that they either knew or should have known was going on for years. In a recent FINRA AWC, that rank hypocrisy is on display for all to see. In keeping with how bad press prompts better regulation, FINRA is now in a tizzy about what we in the trade call "Best Execution."
Case in Point
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, TradeStation Securities, Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of TradeStation Securities, Inc., Respondent (FINRA AWC 2014041812501)
https://www.finra.org/sites/default/files/fda_documents/2014041812501
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No Relevant Disciplinary History
The AWC asserts that TradeStation has been a FINRA member firs since 1996 with about 130 registered persons at four offices. The AWC alleges that TradeStation "does not have any relevant disciplinary history."
Since January 2014
The "Overview" portion of the AWC alleges that:
Since January 2014, TradeStation has predominantly routed its customers' equity and option orders to several market-makers and certain exchanges that paid the Firm for that order flow. As described below, TradeStation did not exercise reasonable diligence to ascertain whether the venues where it routed certain equity and option customer orders provided the best market for the subject securities as compared to the execution quality that was being provided at competing markets. In addition, the Firm did not review the execution quality it was receiving for certain order types. TradeStation also failed to establish and maintain a supervisory system, including written supervisory procedures (WSPs), reasonably designed to achieve compliance with its best execution obligations under FINRA's rules. Finally, the Firm failed to disclose material aspects of its relationship with the markets to which it routed most of its order flow. By virtue of the foregoing, TradeStation violated NASD Rules 3010(a) and (b), FINRA Rules 5310(a), 5310.09, 3110(a) and (b),1 Rule 606 of the Securities Exchange Act of 1934, and FINRA Rule 2010.
Sanctions
Bill Singer's Comment
Did you catch that phrase in the AWC "Overview": Since January 2014. Or, to put that another way: Seven years ago.
As Time Goes By
In reading through the 11-page TradeStation 2021 AWC, it's impossible to overlook the repeated references to misconduct that originated as far back as 2014. For example, consider these extracts [Ed: footnotes omitted]:
From 2014 to September 2016, the Firm prioritized the routing of marketable equity orders to market-makers and exchanges that paid for that order flow. The Firm, however, failed to review separately the execution quality that was provided by each individual market. . . . at Page 5 of the TradeStation 2021 AWC.From April 2016 to May 2019, the Firm reviewed and compared the execution quality it received from each market-maker to which it routed its customers' marketable equity orders. But while the Firm compared the execution quality it received from each market-maker to each other, it only further compared the market-makers' execution quality to the average execution quality of exchanges. . . .at Page 5 of the TradeStation 2021 AWC.From 2014 until January 2017, although the Firm prioritized the routing of nonmarketable orders to exchanges that paid the highest rebates, it did not review the fill rates it received from such markets or evaluate whether it could have received better fill rates from competing markets. at Page 5 of the TradeStation 2021 AWC.From 2014 until September 2019, the Firm prioritized the routing of odd lot equity orders to market-makers that paid the Firm for that order flow. The Firm, however, did not conduct any review of the execution quality it received from these markets for this order type, and did not consider whether it could obtain better execution quality for such order type from competing markets. . . .at Page 5 of the TradeStation 2021 AWC.From 2014 to June 2016, the Firm routed marketable option orders to exchanges and market-makers, which paid the Firm for that order flow. While the Firm conducted a daily random sampling of option orders to confirm they were executed within the National Best Bid and Offer (NBBO), it did not conduct a regular and rigorous review of the execution quality it received from these markets. . . .at Page 6 of the TradeStation 2021 AWC.From 2014 to February 2021, the Firm prioritized the routing of non-marketable option orders to market-makers that paid the Firm for that order flow. Prior to February 2019, the Firm did not conduct reviews of the execution quality it received from those market-makers and did not consider whether the Firm could obtain better execution quality from competing markets. . . .at Page 6 of the TradeStation 2021 AWC.From 2014 to February 2020, the Firm prioritized the routing of multi-leg option orders to market-makers that paid the Firm for that order flow. The Firm, however, did not conduct reviews of the execution quality it was receiving from these market-makers and did not consider whether the Firm could obtain better execution quality from competing markets.. . . .at Page 6 of the TradeStation 2021 AWC.
Okay, sure, so FINRA is taking TradeStation out to the regulator's woodshed. And in wagging a disapproving finger at its member firm, FINRA is trying to make the point that the cited violations were going on for years. It's not just something that happened once or even just last year; oh no, the violations set out in exacting detail in the TradeStation 2021 AWC were ongoing, extensive, of multi-year duration, and they were going on right under the nose of TradeStation.
Okay, sure -- but weren't they also going on right under the nose of FINRA?
I mean, where the hell was FINRA in 2014, and 2015, and 2016, and 2017, and 2018, and 2019, and 2020, and up to February of 2021?
Yeah, I know, it doesn't look so nice when I spell it out like that. Which is why I do it.
No Relevant Disciplinary History
Perhaps FINRA anticipated that some jerk like me would ask how so much misconduct went on right under the regulator's nose for so many years. Fair question, I think: How come FINRA didn't notice jack for seven years? And while we're talking about FINRA anticipating blow-back, maybe that explains why the TradeStation 2021 AWC asserts that "TradeStation does not have any relevant disciplinary history." at Page 1 of the TradeStation 2021 AWC.
Funny thing about that pristine, non-relevant disciplinary history -- according to online FINRA BrokerCheck disclosures as of March 4, 2021, TradeStation has 23 "Final" regulatory events starting in 1997. As to the most recent regulatory event (other than the 2021 AWC), that was published on November 29, 2017: In the Matter of TradeStation Securities, Inc., Respondent (FINRA AWC 20140399429041) (the "TradeStation 2017 AWC").
https://www.finra.org/sites/default/files/fda_documents/2014039942904
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Under the "Summary and Overview" portion of the TradeStation 2017 AWC, the following is asserted [Ed" this AWC refers to "TradeStation Securities Inc. as "FILL"]:
1. In connection with Matter No. 20140399429, the staff of the Trading and Financial Compliance Examination ("TFCE") group, formerly TMMS, of the Department of Market Regulation, on behalf of FINRA and several equity exchanges, reviewed various trading activity of FILL, as well as FILL's written supervisory procedures in several areas, during August 2014 (the "review period"). As a result of this review, TFCE found the trading violations and violations related to FILL's written supervisory procedures set forth below.
According to the TradeStation 2017 AWC, the following sanctions were imposed:
The Firm also consents to the imposition of the following sanctions:1. A censure; and
2. A fine in the amount $125,000, of which $32,500 is payable to FINRA (consisting of a fine of $5,000 for the violations of SEA Rule 10b-10; a fine of $5,000 for the violations of FINRA Rule 2265; a fine of $15,000 for the violations of NASD Rule 3010 and FINRA Rule 2010; and a fine of $7,500 for the violations of SEA Rule 15c3-51).23. Acceptance of this AWC is conditioned upon acceptance of similar settlement agreements in related matters between FILL and each of the following self-regulatory organizations. Cboe BYX Exchange, Inc., Cboe BZX Exchange, Inc., Cboe EDGA Exchange, Inc., Cboe EDGX Exchange Inc., The NASDAQ Stock Market LLC, the New York Stock Exchange LLC, NYSE American LLC, and NYSE Area Inc. . . .= = =FOOTNOTE 1: An additional fine is being imposed against the Finn for violations of SEA Rule 15c3-5 in a related EDGA AWC under STAR Nos. 20140399429, 20160500099 and 20170529501,FOOTNOTE 2: The balance of the sanction will be paid to the self-regulatory organizations listed in Paragraph B.3.
I'm sorry but this is just getting ridiculous and it seems to be a recurring FINRA theme: No disclosure of prior relevant disciplinary histories. Taken as a whole -- the 2021 AWC and the lack of disclosure of prior relevant disciplinary history -- this is nothing more than garbage regulation.
To some extent, I feel sorry for TradeStation. After all, if FINRA had timely cited its member firm in 2014 or 2015 or 2016 or all the ensuing years noted in the 2021 AWC, maybe that would have proven helpful to the firm's compliance staff. Isn't that an important aspect of self regulation? Isn't FINRA supposed to try its damnedest to ferret out things that a member firm's operations and/or compliance staff might be missing? Wouldn't it have been helpful for FINRA Staff to knock on the Chief Compliance Officer's door at TradeStation and say, "hey, we're not sure if you're aware of it but look at what our examination staff has found."
In reading through the TradeStation 2021 AWC, I come to the uneasy conclusion that the Congressional formula referenced by former SEC Chair Levitt (the 1938 Maloney Act) no longer works. It is a wheezing relic from an age before atomic energy, before television, before computers, before the Internet. Even since Levitt's dour pronouncements of 1996, the markets have become ever more innovative and ever more fast-moving. Not only did self-regulation go off track in 1996 but it continues to derail.
I mean seriously -- regardless of how ardent a supporter you are of Wall Street self-regulation -- what good is it to sanction any Respondent for misconduct that's seven years old? And what does it say of the state of Wall Street self-regulation when a settlement involves misconduct that isn't merely seven years old but has gone on during each of those seven years?
SEC Chair Arthur Levitt's 1996 NASD/NASDAQ Statement
What is set forth in the TradeStation 2021 AWC is not merely the shortcomings of a member firm but also the failure of a self-regulatory-organization. All of which harkens back to that dark day on August 8, 1996, when SEC Chairman Arthur Levitt announced an historic enforcement action against the National Association of Securities Dealers, the predecessor to FINRA. In the Statement that he issued that day
https://www.sec.gov/news/speech/speecharchive/1996/spch113.txt, Levitt noted in part that:
https://www.sec.gov/news/speech/speecharchive/1996/spch113.txt, Levitt noted in part that:
Our securities markets operate under a "self-regulatory" system. Markets serve an important public interest, and deserve public oversight; but markets are also innovative and fast-moving, and easily stifled by the heavy hand of government.So Congress arrived at a formula in which the industry polices itself, with SEC oversight. This keeps us out of most day-to-day affairs, and allows us to keep our hands off, but our eyes open. And on those rare occasions when self-regulation goes off track, the SEC must act in the public interest.This is one of those occasions.. . .Where was the NASD, the cop on the Nasdaq beat?The NASD was not blind to these practices in the marketplace. It simply looked the other way. . . .
In reading through the TradeStation 2021 AWC, I come to the uneasy conclusion that the Congressional formula referenced by former SEC Chair Levitt (the 1938 Maloney Act) no longer works. It is a wheezing relic from an age before atomic energy, before television, before computers, before the Internet. Even since Levitt's dour pronouncements of 1996, the markets have become ever more innovative and ever more fast-moving. Not only did self-regulation go off track in 1996 but it continues to derail.
When I look at the TradeStation 2021 AWC, I ask "where was FINRA, the cop on the FINRA member firm beat?" I have no problem and I take no issue with the Censure and fine imposed upon TradeStation. I have a problem and take issue with FINRA's smugness in failing to recognize its own failures. If FINRA is not blind to its member firms' practices in the marketplace, then how else are we to explain why in 2021, FINRA is only now addressing marketplace misconduct that it alleges occurred in 2014? Perhaps the answer is set out in unintended stunning detail in the TradeStation 2021 AWC: FINRA looked the other way.