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November 10, 2009

Brokers Warned About Phony IOIs

By Nina Mehta

The Financial Industry Regulatory Authority warned broker-dealers not to misrepresent so-called natural indications of interest they send out to institutions.

Jon Kroeper, senior vice president at FINRA, said at the Investment Company Institute's September conference in New York that broker-dealers sending out traditional IOIs "through their OMSs or a service provider" must play by the rules.

They must "be sure the information is accurate and not purposefully misleading," he said. If they send out IOIs tagged as naturals, they must have natural orders in hand and for the size they're advertising.

If a firm represents "natural trading interest" and doesn't have it, "that's a concern," Kroeper said. He also said that "when a firm puts out an IOI with a size and that's not what they have"--as in, they never had that size order or it's no longer available--that's another cause for regulatory concern. The most popular IOI distribution services are Bloomberg and Tradeweb (formerly known as AutEx).

A few months ago, in May, FINRA issued a notice to member firms warning them to tell the truth when they send out natural IOIs. Naturals, it said, are supposed to represent orders a broker-dealer is working for a customer on an agency interest. They may also represent the firm's proprietary interest resulting from a riskless principal trade.

Kroeper added that FINRA is not looking to define what a natural IOI is. However, he said, "we want to make sure that firms, when they use these systems ... use them consistently." This problem of sending out misleading IOIs isn't new. IOIs can be a useful way to source block liquidity, and a tool to let buysider traders and others know who's the axe in a particular stock. But IOIs can also be used by brokers to draw out information about block flow that institutions are reluctant to divulge.

Despite FINRA's focus on truth, Kroeper noted, not all IOIs must be treated with such care. Non-natural IOIs can be vague or function as come-ons. IOIs "by their nature can be very vague, can just give an indication that someone wants to trade in a security," Kroeper said. There's "nothing misleading about that." He added: "Vagueness itself is not a crime or an issue" as long as the IOIs are not pitched as naturals.


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