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Panel TA: Compliance Considerations in Institutional Fixed Income [CPM] [CPL]

Edward McLaren Compliance and Operations Risk Executive Bank of America Merrill Lynch

Panelists

Elizabeth H. Baird Deputy Director Division of Trading and Markets U.S. Securities and Exchange Commission

Andrew Mayo Head of US Fixed Income Compliance and Co-Head of US Sales & Trading Compliance Morgan Stanley

Marlon Q. Paz Partner Mayer Brown LLP

Marjan Quadir Director, Global Markets Compliance Citigroup Global Markets Inc.

Corwin Wyatt Head of Fixed Income Compliance Jefferies

Moderator

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Table of Contents

1 LONDON INTERBANK OFFERED RATE (LIBOR) TRANSITION ...........................1 1.1 Regulators Focus on Mandate to Transition During 2020 ................................................1 1.2 2020 OCIE and FINRA Exam Priority .............................................................................1 1.3 Managing the Transition from LIBOR..............................................................................2

2 HANDLING OF CONFIDENTIAL INFORMATION ....................................................6 2.1 Treasury Market Practices Group (TMPG) Encourages Implementation of Best Practice

Recommendations on Information Handling ....................................................................6

3 ELECTRONIC TRADING - BEST PRACTICES FOR ALGORITHMIC TRADING ..8 3.1 Review use of algorithms within your firm. .....................................................................8 3.2 Define and require adherence to minimum standards relevant to algorithmic trading and

related systems. .................................................................................................................9 3.3 Establish a robust development and testing process, and appoint a project lead. .............9 3.4 Involve senior management in the development and testing process and have

compliance do a gap analysis. .........................................................................................10 3.5 Maintain detailed risk controls at multiple levels, review them regularly, and have an

independent risk function oversee the process................................................................10 3.6 Set up dedicated teams to monitor activity. ....................................................................10 3.7 Implement and document mandatory training of all relevant members of staff. ............10

4 SPOOFING PROSECUTIONS ......................................................................................10 4.1 Overview .........................................................................................................................10 4.2 Spoofing Prohibition in the Futures and Derivatives Markets ........................................10 4.3 Spoofing Prohibition in The Securities Markets .............................................................11 4.4 Sample Pattern.................................................................................................................12 4.5 Key Focus of Prosecutors ................................................................................................12 4.6 Lek Securities Corporation..............................................................................................13 4.7 In re Bank of Tokyo-Mitsubishi UFJ – Value of Cooperation .......................................14

5 BEST EXECUTION / MARK-UP .................................................................................14 5.1 OCIE Exam Priorities......................................................................................................15 5.2 FINRA Best Execution Obligations ................................................................................15

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5.3 FINRA Best Execution Examination Findings ...............................................................15 5.4 FINRA Fixed Income Mark-up Obligations ...................................................................16 5.5 FINRA Mark-up Examination Findings .........................................................................16

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1 London Interbank Offered Rate (LIBOR) Transition

1.1 Regulators Focus on Mandate to Transition During 2020

1.1.1 LIBOR is an indicative measure of the average interest rate at which major global banks could borrow from one another. LIBOR is used extensively in the United States and globally as a “benchmark” or “reference rate” for various commercial and financial contracts, including corporate and municipal bonds and loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives.

1.1.2 LIBOR has been subject to a scandal of rigging, fraud and collusion amongst these banks. As a result, the United Kingdom Financial Conduct Authority (FCA) has urged banks and institutions to move to other benchmarks by 2021, and will no longer require or encourage banks to publish these rates following 2021.

1.1.3 Possible alternatives include the Secured Overnight Financing Rate (SOFR) for the US, the Sterling Overnight Index Average (SONIA) for the UK, the Swiss Average Overnight Rate (SARON) for Switzerland and the Tokyo Overnight Average Rate (TONA) for Japan.

1.1.4 On July 12, 2019, the SEC encouraged market participants to proactively manage their transition away from LIBOR and outlined several potential areas that may warrant increased attention during that time.1

1.2 2020 OCIE and FINRA Exam Priority

1.2.1 In its 2020 Exam Priorities report,2 the Securities and Exchange Commission’s Office of Compliance Inspections and examinations (OCIE) noted that:

“For example, as our registrants and other market participants transition away from LIBOR as a widely used reference rate in a number of financial instruments to an alternative reference rate, OCIE will be reviewing firms’ preparations and disclosures regarding their readiness, particularly in relation to the transition’s effects on investors. Some registrants have

1 Staff Statement on LIBOR Transition, Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant, Securities and Exchange Commission, available at, https://www.sec.gov/news/public-statement/libor-transition.

2 OCIE 2020 Exam Priorities report, available at, https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2020.pdf.

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already begun this effort and OCIE encourages each registrant to evaluate its organization’s and clients’ exposure to LIBOR, not just in the context of fallback language in contracts, but its use in benchmarks and indices; accounting systems; risk models; and client reporting, among other areas. Insufficient preparation could cause harm to retail investors and significant legal and compliance, economic and operational risks for registrants.”

1.2.2 On January 9, 2020, the Financial Industry Regulatory Authority, Inc. (FINRA) released its 2020 Risk Monitoring and Examination Priorities Letter,3 noting that FINRA will engage with firms – outside the examination program – to understand how they are preparing for the 2021 phase-out of LIBOR. FINRA’s engagement is intended to be outside the examination program and focus on firms’ exposure to LIBOR-linked financial products, steps firms are taking to plan the transition to alternative rates, and the impact of the LIBOR phase-out on customers.

1.3 Managing the Transition from LIBOR

1.3.1 Existing Contracts

SEC staff encourages market participants who have not already done so to begin the process of identifying existing contracts that extend past 2021 to determine their exposure to LIBOR.

In particular, SEC staff encourages market participants to consider questions along the lines of the following as they seek to understand and mitigate the risks related to the transition from LIBOR.

1.3.1.2.1 Do you have or are you or your customers exposed to any contracts extending past 2021 that reference LIBOR? For companies considering disclosure obligations and risk management policies, are these contracts, individually or in the aggregate, material?

1.3.1.2.2 For each contract identified, what effect will the discontinuation of LIBOR have on the operation of the contract?

1.3.1.2.3 For contracts with no fallback language in the event LIBOR is unavailable, or with fallback language that does not contemplate the expected permanent

3 FINRA 2020 Risk Monitoring and Examination Priorities Letter, available at, https://www.finra.org/sites/default/files/2020-01/2020-risk-monitoring-and-examination-priorities-letter.pdf.

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discontinuation of LIBOR, do you need to take actions to mitigate risk, such as proactive renegotiations with counterparties to address the contractual uncertainty?

1.3.1.2.4 What alternative reference rate (for example, SOFR) might replace LIBOR in existing contracts? Are there fundamental differences between LIBOR and the alternative reference rate – such as the extent of or absence of counterparty credit risk – that could impact the profitability or costs associated with the identified contracts? Does the alternative reference rate need to be adjusted (by the addition of a spread, for example) to maintain the anticipated economic terms of existing contracts?

1.3.1.2.5 For derivative contracts referencing LIBOR that are utilized to hedge floating-rate investments or obligations, what effect will the discontinuation of LIBOR have on the effectiveness of the company’s hedging strategy?

1.3.1.2.6 Does use of an alternative reference rate introduce new risks that need to be addressed? For example, if you have relied on LIBOR in pricing assets as a natural hedge against increases in costs of capital or funding, will the new rate behave similarly? If not, what actions should be taken to mitigate this new risk?

1.3.2 New Contracts

Market participants also should consider whether contracts entered into in the future should reference an alternative rate to LIBOR (such as SOFR) or, if such contracts reference LIBOR, include effective fallback language.

In the U.S., the Alternative Reference Rates Committee (“ARRC”), a group convened by the Federal Reserve Board and the Federal Reserve Bank of New York, has published recommended fallback language for new issuances of floating rate notes, syndicated loans, bilateral business loans, and securitizations.

In addition, the International Swaps and Derivatives Association (“ISDA”), which maintains industry standard swaps and derivatives documentation, has been leading an industry effort to implement robust fallback language for derivatives contracts since 2016, at the request of the Financial Stability Board’s Official Sector Steering Group.

1.3.3 Guidance from the Division of Trading and Markets

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The Division of Trading and Markets is actively monitoring the impact that the expected discontinuation of LIBOR will have on broker-dealers, central counterparties, and exchanges.

The Division of Trading and Markets encourages these entities:

1.3.3.2.1 to analyze how this change will impact them – their business, systems, models, processes, risk management frameworks, and clients – and to respond accordingly.

1.3.3.2.2 to consider whether their clients and the markets should be informed of risks related to this change.

1.3.4 Guidance from the Division of Investment Management

The Division of Investment Management is actively monitoring the impact that the expected discontinuation of LIBOR will have on investment companies and advisers, particularly those that invest in instruments referencing LIBOR, such as floating rate debt, bank loans, LIBOR-linked derivatives, and certain asset-backed securities.

The discontinuation of LIBOR may impact the functioning, liquidity, and value of these investments. Even funds that do not invest in instruments linked to LIBOR could be impacted by the discontinuation of LIBOR.

The Division of Investment Management encourages affected funds to provide investors with tailored risk disclosure that specifically describes the impact of the transition on their holdings.

1.3.5 Guidance from the Division of Corporation Finance

The Division of Corporation Finance noted that a number of existing rules or regulations may require disclosure related to the expected discontinuation of LIBOR, including rules and regulations related to disclosure of risk factors, management’s discussion and analysis, board risk oversight, and financial statements.

Companies are urged to keep investors informed about the progress toward risk identification and mitigation, and the anticipated impact on the company, if material.

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In deciding what disclosures are relevant and appropriate, Corporation Finance encourages companies to consider the following guidance.

1.3.5.3.1 The evaluation and mitigation of risks related to the expected discontinuation of LIBOR may span several reporting periods. Consider disclosing the status of company efforts to date and the significant matters yet to be addressed.

1.3.5.3.2 When a company has identified a material exposure to LIBOR but does not yet know or cannot yet reasonably estimate the expected impact, consider disclosing that fact.

1.3.5.3.3 Disclosures that allow investors to see this issue through the eyes of management are likely to be the most useful for investors. This may entail sharing information used by management and the board in assessing and monitoring how transitioning from LIBOR to an alternative reference rate may affect the company. This could include qualitative disclosures and, when material, quantitative disclosures, such as the notional value of contracts referencing LIBOR and extending past 2021.

1.3.6 Guidance from the Office of the Chief Accountant

The Chief Accountant is actively monitoring the activities underway among preparers and auditors of financial statements, standard setters such as the Financial Accounting Standards Board (“FASB”), and other regulators, to address financial reporting issues that might arise in connection with any transition from LIBOR to an alternative benchmark rate.

The Chief Accountant recognizes that an interest rate benchmark can have a pervasive impact on a company’s financial reporting, and that transitioning from one benchmark rate to another benchmark rate can also have a significant impact on a company’s accounting.

The Chief Accountant encourages constituent participation in the standard-setting process as both the FASB and the IASB will benefit from the active engagement and involvement of the various parties involved in the financial reporting ecosystem.

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2 Handling of Confidential Information

2.1 Treasury Market Practices Group (TMPG) Encourages Implementation of Best Practice Recommendations on Information Handling

2.1.1 TMPG recognizes the importance of maintaining the integrity and efficiency of the U.S. government securities (Treasury), agency debt, and agency mortgage-backed-securities (MBS) markets. Appropriate handling of confidential information is important to promote the integrity and efficiency of the Treasury, agency debt, and agency MBS markets. The misuse of confidential information adversely affects the integrity of the market by undermining trust and confidence and, moreover, may constitute illegal activity. Nevertheless, there are legitimate reasons for appropriately sharing and using confidential information in certain circumstances.

2.1.2 TMPG recommended that market participants implement the information handling best practices.4

2.1.3 Confidential information may include non-public information – received or created by a market participant or its counterparties – relating to their past, present, and future trading activity or positions. The nature and types of confidential information may vary across firms, including the identity of market participants, their positions or trading strategies, details of their order book (size and type of trades - limit, market, etc.), or axes.

Market participants should communicate in a manner that is clear and truthful. Market participants also should not omit any material fact or qualification if the omission would cause the communications to be misleading.

Market participants should not share or use confidential information with the intent of adversely affecting the interests of other market participants or the integrity of the market.

Market participants should limit sharing and use of confidential information. Market participants should exercise care in disclosing confidential information, including own position information and information received from counterparties or third parties, whether internally or externally.

4 TMPG Best Practice Recommendations on Information Handling with Illustrative Examples, available at, https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/TMPG_Info_Sharing_Examples.pdf.

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2.1.3.3.1 Internal sharing: Confidential information should not be shared internally except on a need-to-know basis.

2.1.3.3.2 External sharing: Market participants should not disclose confidential information to other market participants that could reasonably enable those market participants to anticipate the flows of a specific counterparty, including flows or information related to transactions to be executed at a to-be-determined time or level. Confidential information about specific pending or executed trades may be shared externally only to the extent necessary to facilitate the execution, clearing, or settlement of a transaction (which may include arranging offsetting transactions).

2.1.3.3.2.1 Market color: Market color should be shared in a manner that does not disclose any confidential information. For example, market color should not directly or indirectly reveal confidential information about specific (i) market participants’ identity, (ii) times of execution, (iii) pending trading activity or orders (including entry and exit points), and (iv) position size.

2.1.3.3.2.2 Own position information: Market participants should not disclose confidential information related to their own trading positions with the intent to influence market prices or negatively impact market functioning. Market participants should exercise particular care when sharing confidential information related to their own trading positions, especially when it is a large position relative to the floating supply. Confidential information related to trading positions may include, but is not limited to, individual trades, open orders, positions or investments, axes, and inventory. Confidential information related to one’s own trading position may be shared externally only to the extent necessary to facilitate an executed or potential transaction or to obtain an independent valuation. Confidential information shared with third parties for the purpose of facilitating an executed or potential transaction or obtaining an independent valuation should be limited to that which is necessary for these activities.

Market participants should adopt written policies and procedures that identify and address the handling of confidential information, including limitations on the sharing and use of such information. The policies may vary across firms and across business lines within firms and should address risks, where they exist, associated with:

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2.1.3.4.1 Sharing of information: The extent to which confidential information, including pre- and post-trade information, can be shared internally or externally. The policies should also address the extent to which confidential information should be aggregated or anonymized prior to sharing.

2.1.3.4.2 Use of information: The extent to which confidential information may be used, including, for example, in activities such as customer facilitation, investment decisions, trading and hedging.

All market participants should be aware of their counterparties’ practices for handling confidential information; market participants should make available their practices for handling confidential information to their counterparties. Such practices may be high-level summaries of internal policies and may include, but are not limited to, the handling of confidential information related to requests for quotes, requests for indicative prices, valuations, axes or other indications of trading interest, cover information, the placement of orders, inventory, and details of completed transactions.

Market participants should establish internal controls designed to ensure that confidential information is handled in a manner that complies with their established policies. Such internal controls may include training of employees who have access to confidential information.

3 Electronic Trading - Best practices for algorithmic trading

The use of computer algorithms which are capable of automatically determining individual parameters of orders (Algorithms) to facilitate trading in fixed income markets continues to increase year over year. A significant amount of order flow is handled by algorithms. Algorithmic trading can reduce exposure to conduct risk by decreasing human error. However, algorithmic trading can carry significant conduct risks, either due to mistakes and errors in implementation or intentional design features, that may lead to major fines and reputational damage as well as loss of trust and business. Regulators have thought long and hard about how to strike a balance between enabling market efficiency and protecting market integrity.

3.1 Review use of algorithms within your firm.

3.1.1 Identify the different types of algorithms, trading strategies and systems, including relevant operational objectives, parameters and behavioral characteristics.

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3.1.2 Document who “owns” the algorithms and who is approved to operate the strategy or system.

3.1.3 Establish policies on the completion of development, validation and testing procedures, along with appropriate sign off from senior management and other relevant control functions.

3.2 Define and require adherence to minimum standards relevant to algorithmic trading and related systems.

3.2.1 risk and execution controls;

3.2.2 kill switches;

3.2.3 testing practices;

3.2.4 monitoring;

3.2.5 continuity of business;

3.2.6 change processes; and

3.2.7 documentation requirements.

3.3 Establish a robust development and testing process, and appoint a project lead.

3.3.1 Break down the process into separate phases and establish independent checks and balances at each stage.

3.3.2 Conduct due diligence checks to assess potential risk and establish risk control thresholds.

3.3.3 Test the systems to see how they perform in extremely volatile conditions.

3.3.4 Open communication between different business units is good, but a separate team should verify and checks the output and quality of the code.

3.3.5 Establish a formal approval and sign-off process.

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3.4 Involve senior management in the development and testing process and have compliance do a gap analysis.

3.5 Maintain detailed risk controls at multiple levels, review them regularly, and have an independent risk function oversee the process.

3.6 Set up dedicated teams to monitor activity.

3.7 Implement and document mandatory training of all relevant members of staff.

4 Spoofing Prosecutions

4.1 Overview

4.1.1 Spoofing remains an enforcement priority for the Department of Justice (DOJ), SEC, and Commodity Futures Trading Commission (CFTC), despite setbacks.

4.1.2 “Spoofing” is generally refers to a pattern in which a trader places and quickly cancels an order that was never intended to be executed. The order alters the appearance of supply and demand, thereby causing prices to move up or down.

4.1.3 “Layering,” is a specific form of spoofing. With layering, the trader places a series of non-bona fide orders increasingly far from the prevailing best price (that is, orders to sell at increasingly higher prices than the prevailing lowest asking price, or orders to buy at increasingly lower prices than the prevailing highest bid price) in order to give the false appearance of market depth.

"Layering and spoofing undermine the transparency and integrity of the markets. As the jury recognized, such fraudulent conduct violates the securities laws, and has no place in our markets,"5

Steven Peikin, Co-Director of the SEC's Division of Enforcement.

4.2 Spoofing Prohibition in the Futures and Derivatives Markets

4.2.1 Section 4c(a)(5)(C) of the the Commodity Exchange Act (CEA) prohibits “any trading, practice, or conduct on or subject to the rules of a registered entity that . . . is, is of the character of, or is commonly known to the trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).” 7 U.S.C. § 6c(a)(5)(C) (2012).

5 https://www.sec.gov/news/press-release/2019-236.

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4.2.2 The CEA, amended by Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, is the first U.S. statutory provision to specifically prohibit spoofing in commodity markets.

4.2.3 According to Guidance released by the CFTC in 2013, the spoofing prohibition applies to activity on all registered trading facilities, including in pre-open periods and during exchange-controlled trading halts. It does not cover block trades, bilaterally negotiated swap transactions, exchanges for related positions, or non-executable market communications such as requests for quotes. It applies regardless of a trading platform’s order book functionality.6

4.2.4 The CFTC provided “four non-exclusive examples of possible situations” constituting spoofing.

“Submitting or cancelling bids or offers to overload the quotation system of a registered entity”

“Submitting or cancelling bids or offers to delay another person’s execution of trades”

“Submitting or cancelling multiple bids or offers to create an appearance of false market depth”

“Submitting or cancelling bids or offers with intent to create artificial price movements upwards or downwards”

4.2.5 The CFTC has noted that “a spoofing violation will not occur when the person’s intent when cancelling a bid or offer before execution was to cancel such bid or offer as part of a legitimate, good-faith attempt to consummate a trade.”

4.3 Spoofing Prohibition in The Securities Markets

4.3.1 The securities statutes do not outlaw spoofing by name – rather, spoofing and layering are characterizing as a manipulative practice.

4.3.2 The SEC’s spoofing cases generally are premised on violations of the antifraud and antimanipulation prohibitions of Exchange Act Section 10(b) (15 U.S.C. § 78j) and Rule 10b-5 (17 C.F.R. 210.10b-5), as well as Section 17(a) of the Securities Act, 15 U.S.C. §

6 CFTC, Antidisruptive Practices Authority, 78 Fed. Reg. 31890 (May 28, 2013).

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77q(a). In addition, SEC spoofing cases have also invoked Exchange Act Section 9(a)(2), 15 U.S.C. § 78i (2015), which makes it unlawful “[t]o effect . . . a series of transactions . . . creating actual or apparent active trading in [a security], or raising or depressing the price [of a security], for the purpose of inducing the purchase or sale of such security by others.”

4.3.3 The SEC has also accused broker-dealers whose accounts were used by others who engaged in spoofing or layering of violating the Market Access Rule (SEC Rule 15c3-5, 17 C.F.R. § 240.15c3-5) and other supervisory requirements.

4.3.4 FINRA has brought enforcement actions against spoofing and layering by alleging violations of just and equitable principles of trade (FINRA Rule 2010), market access deficiencies (Exchange Act § 15(c)(3) and Rule 15c3-5 thereunder), and/or supervisory failures (FINRA Rule 3110).

4.4 Sample Pattern

4.4.1 The trader places a small buy order that he wants to execute.

4.4.2 This is quickly followed with a large sell order at a higher price that the trader intends to cancel.

4.4.3 By placing the large sell orders, the trader seeks to give the market the impression that there is significant selling interest.

4.4.4 The market price falls and the small buy order is filled.

4.4.5 Once the small buy order is filled, the large buy order is quickly cancelled because the trader did not place the order to get filled on the order, but rather to impact the market.

4.5 Key Focus of Prosecutors

4.5.1 When the trader enters an order, does the trader intend to cancel it before the order is filled?

“u gotta be quick with spoofs cause everyone else knows the trick too...”

“Basically i sold out . . . by just having fake bids . . . [in] the futures . . . i just spam bids below . . . to clear my offer.”

“Priority game – when the market goes from bid to offer flash an order there, see what happens at the next price/who comes behind you. . . .”

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4.5.2 Intent Analysis:

Order duration (e.g., one second or less)

Frequency of cancellations (e.g., more than 98%)

Fill rates

Market impact / complaints

Asymmetrical orders on both sides of the market

Cancellations in response to fills

Complaints by one or more market participants

Use of wash blocker

4.6 Lek Securities Corporation

4.6.1 On October 1, 2019, a federal court judge entered final judgments against New York-based brokerage firm Lek Securities Corp. and Chief Executive Officer Sam Lek, who were charged by the SEC with facilitating manipulative U.S. trading by a Ukraine-based firm over a three-year period. https://www.sec.gov/news/press-release/2019-205

4.6.2 The SEC’s complaint7 alleged that Lek Securities and Sam Lek helped facilitate manipulative trading schemes by its customer, Avalon FA Ltd., headquartered in Kiev. According to the complaint, Avalon illegally profited by placing and canceling orders to trick others into buying or selling stocks at artificial prices, and cross-market manipulation, which involved buying or selling stocks to artificially impact options prices. The SEC’s complaint alleged that Lek Securities and Sam Lek made the schemes possible by giving Avalon access to the U.S. markets, relaxing the brokerage firm’s layering controls after Avalon complained, allowing Avalon to conduct the trading activity, and improving Lek Securities’ technology to assist Avalon’s trading.

7 https://www.sec.gov/litigation/complaints/2017/comp-pr2017-63.pdf

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4.6.3 Several SROs, (FINRA, NASDAQ, BX, PHLX, ISE, NYSE, NYSE Arca, NYSE American, Cboe, BZX, BYX, EDGA, and EDGX) permanently barred Samuel Lek and Fine Lek Securities Corporation for supervisory and market access rule violations.8

4.7 In re Bank of Tokyo-Mitsubishi UFJ – Value of Cooperation

4.7.1 The CFTC settled allegations that a BTMU trader had engaged in spoofing in violation of the CEA. The consent order set forth an extensive list of BTMU’s cooperative efforts, including that BTMU:

promptly suspended the trader;

reported the conduct to the DOE;

commenced an expansive internal review;

provided assistance to the DOE, which expedited the investigation;

launched an overhaul of BTMU’s systems and controls; and

implemented a variety of enhancements to detect and prevent similar misconduct, including revising its policies, updating its training and implementing electronic systems to identify spoofing.

5 Best Execution / Mark-Up

The market for fixed income securities has evolved significantly in recent years. As the availability of electronic systems that facilitate trading in fixed income securities increases, firms need to update their best execution analysis. FINRA has noted that different systems provide different levels of price information and execution functionality, and that a firm's analysis of the available pricing information offered by different systems may take these differences into account.9 Supplementary Material .03 to Rule 5310 specifically addresses the application of the best execution rule to the fixed income market when assessing the accessibility of a quotation.

8 https://www.finra.org/media-center/newsreleases/2019/finra-nasdaq-bx-phlx-ise-nyse-nyse-arca-nyse-american-cboe-bzx-byx?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+FINRANews+%28FINRA+News%29.

9 https://www.finra.org/rules-guidance/notices/15-46

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5.1 OCIE Exam Priorities

5.1.1 OCIE noted that it will examine broker-dealer trading activity in municipal and corporate bonds for compliance with best execution obligations; fairness of pricing, markups and mark-downs, and commissions; and confirmation disclosure requirements, including retail disclosures relating to mark-ups and mark-downs.

5.2 FINRA Best Execution Obligations

5.2.1 FINRA Rule 5310 (Best Execution and Interpositioning) requires firms to conduct a “regular and rigorous” review of the execution quality of customer orders if the firm does not conduct an order-by-order review.16 Where “regular and rigorous” reviews are used instead of order-by-order reviews, the reviews must be performed at a minimum on a quarterly basis and on a security-by-security, type-of-order basis (e.g., limit order, market order and market on open order). If a firm identifies any material differences in execution quality among the markets that trade the securities under review, it must modify its routing arrangements or justify why it is not doing so.

5.3 FINRA Best Execution Examination Findings

5.3.1 In its Report on FINRA Examination Findings, FINRA continued to identify issues with some firms’ execution quality reviews, as well as conflicts of interest and related disclosures.

No Execution Quality Assessment of Competing Markets – Some firms did not compare the quality of the execution of their existing order routing and execution arrangements against the quality of executions that the firm could have obtained from competing venues.

No Review of Certain Order Types – In some instances, firms did not conduct adequate reviews on a type-of-order basis, including, for example, on market, marketable limit or non-marketable limit orders.

No Evaluation of Required Factors – Some firms did not consider factors set forth in FINRA Rule 5310 (Best Execution and Interpositioning) when conducting their execution quality reviews, including, among other things, the speed of execution, price improvement opportunities and the likelihood of execution of limit orders.

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Conflicts of Interest – Some firms did not adequately consider and address potential conflicts of interest relating to their routing of orders to affiliated alternative trading systems (ATSs) or market centers that provide payment for order flow or other routing inducements. In addition, some firms continue to route significant portions of their order flow to such venues without conducting an adequate “regular and rigorous” review to support such routing decisions.

Inadequate SEC Rule 606 Disclosures – Some firms did not provide adequate information in the material disclosures section of their order routing reports required by Rule 606 of Regulation NMS.

5.4 FINRA Fixed Income Mark-up Obligations

5.4.1 FINRA’s and the Municipal Securities Rulemaking Board’s (MSRB) amendments to FINRA Rule 2232 (Customer Confirmations) and MSRB Rule G-15 require firms to provide additional transaction-related pricing information to retail customers for certain trades in corporate, agency and municipal debt securities (other than municipal fund securities).

5.5 FINRA Mark-up Examination Findings

5.5.1 FINRA identified many of the issues previously discussed in the Fixed Income Mark-up Disclosure section of the 2018 Report, as well as the following additional issues.

Excluding Charges from Mark-Up/Mark-Down Disclosure – Some firms disclosed additional charges separately from disclosed mark-ups or mark-downs, even when such charges reflected firm compensation.

Unclear or Inaccurate Labels for Sales Credits or Concessions – Some firms disclosed registered representatives’ sales credits or concessions as separate line items on confirmations, in addition to the mark-up or mark-down, without clear and accurate labeling, creating confusion about the actual disclosed mark-up and therefore diminishing its utility. Similarly, some firms inaccurately labeled only the sales credits or concessions portion as the total mark-up or mark-down.

Incorrect Prevailing Market Price (PMP) Determinations –Some firms did not determine the PMP as set forth in FINRA Rule 2121.02(b) (Additional Mark-Up Policy for Transactions in Debt Securities, Except Municipal Securities) for their fixed income transactions.

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Mayer Brown is a global services provider comprising associated legal practices that are separate entities, including Mayer Brown LLP (Illinois, USA), Mayer Brown International LLP (England), Mayer Brown (a Hong Kong partnership) and Tauil & Chequer Advogados (a Brazilian law partnership) (collectively the “Mayer Brown Practices”) and non-legal service providers, which provide consultancy services (the “Mayer Brown Consultancies”). The Mayer Brown Practices and Mayer Brown Consultancies are established in various jurisdictions and may be a legal person or a partnership. Details of the individual Mayer Brown Practices and Mayer Brown Consultancies can be found in the Legal Notices section of our website.

Inaccurate Time of Execution – Some firms disclosed times of execution on

customer confirmations that did not match the times of execution disseminated by the Electronic Municipal Market Access system (EMMA) or Trade Reporting and Compliance Engine (TRACE).