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July 6, 2009

FINRA Warns Brokers on IOIs

By Nina Mehta

Traders say their word is their bond. But that may not always apply to their indications of interest, or IOIs. The Financial Industry Regulatory Authority issued a notice in late May reminding traders of their obligation to send out truthful IOIs.

The issue of accuracy in IOIs is as old as the tool itself, which is used by upstairs desks to source contra-side flow. Broker-dealers send out IOIs through their own systems or those of vendors such as Tradeweb's AutEx, Bloomberg and NYFIX. FINRA warned member firms that, "to the extent that they disseminate or use such services to communicate indications of interest, such indications must be truthful, accurate and not misleading."

FINRA's warning focused on "natural" IOIs. The concern is that brokers, to elicit phone calls from buyside traders, may be playing fast and loose with what they're claiming are natural IOIs. Naturals are supposed to represent orders a broker-dealer is working.

The problem is that brokers may not have the order that's supposedly behind the indication, or it may be for a much smaller size. Some brokers may be fishing for information. But by the time the buyside firm discovers this, it's too late because the trader has already picked up the phone and exposed his intentions. None of the IOI service providers police brokers' use of the naturals tag on IOIs.

To avoid confusion, FINRA defined naturals in its May guidance. "A 'natural' indication of interest may be considered to solely refer to interest a firm represents on an agency basis, or refer not only to agency interest but also proprietary interest in certain specific contexts (e.g., proprietary interest that was established as the result of the facilitation of a customer order or the execution of a customer order on a riskless principal basis)," according to the self-regulatory organization.

FINRA issued Regulatory Notice 09-28 to member firms after talking to institutions over the last year. "We have been hearing anecdotally from buyside firms and other market participants, at an increasing rate over the past year, regarding issues with firms' representations as to whether an IOI is truly a natural IOI or not," Herb Perone, a FINRA spokesman, told Traders Magazine.

According to Perone, IOIs have gained more notice by the buyside as institutions seek "to execute in size and the average execution size on the exchange markets and ATSs alike have generally decreased." He added that "the less reliable the information is in IOIs broadcast by firms themselves or through vendors, the less useful it is to those seeking to execute orders." This latest FINRA bulletin follows one in September 2006, when FINRA told member firms to be truthful in their advertisements of trading volume.

FINRA told member firms not to run afoul of its latest guidance. False or misleading IOIs, FINRA said, could violate NASD Rule 3310 (Publication of Transactions and Quotations) and IM-3310 (Manipulative and Deceptive Quotations).


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