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December 16, 2010

2010 Review: FINRA Has It All (Almost)

By Peter Chapman

The markets may be fragmenting, but surveillance of those markets is consolidating. With its takeover of NYSE Regulation's market surveillance duties this June, the Financial Industry Regulatory Authority now oversees trading on every stock exchange except those operated by BATS Global Markets and Direct Edge. That takes in roughly 80 percent of all shares traded.

The arrangement with NYSE Regulation puts the staff of FINRA's market regulation group at roughly 450 and gave it responsibility for NYSE Classic, NYSE Arca and NYSE Amex, as well as NYSE Euronext's two options markets. Most of the 225-person staff of NYSE Reg joined FINRA, including such senior executives as Robert Marchman and John Malitzis. In total, FINRA employs about 3,100.

FINRA will spend the next two years combining order and execution data emanating from the NYSE facilities with its own, said Tom Gira, in charge of market regulation at FINRA. It is constructing a large "hub."

"It's a big technology lift to bring all that data together and maintain it in a way that you can run surveillance across it," Gira said.

As part of the takeover, FINRA gained access to the NYSE's Order Tracking System, into which brokers must report their orders and trades. OTS is similar to FINRA's OATS, or Order Audit Trail System, which covers trades in Nasdaq securities. NYSE still owns OTS, but FINRA has the rights to some of the applications.

FINRA's goal is to switch all NYSE members over to OATS. Once that happens, the NYSE will likely decommission OTS. FINRA is now seeking permission from the Securities and Exchange Commission to make the switch.

FINRA's plans for OATS don't stop at the NYSE. In the wake of the May "flash crash," the SEC ordered the exchanges and FINRA to come up with a plan to create a consolidated audit trail that would aggregate trades across the entire marketplace. With no central source of data to help it determine the cause of the flash crash, the SEC decided one must be built.

Despite SEC skepticism that existing audit trail mechanisms could be "retrofitted," FINRA has pitched OATS as the natural solution to the problem. FINRA faces competition from other technology providers, but has the support of the Securities Industry & Financial Markets Association.

"The SEC should strongly consider leveraging OATS," Gira said, "because it is there and firms are used to it." Some sources have indicated it could take as long as two years to build a consolidated audit trail from scratch.

The SEC's consolidated audit trail proposal calls for a central repository to which the SEC would be granted access, as would FINRA and any of the exchanges. In its proposal, however, the SEC does not seek to invest any single party with the authority to surveil all the markets.

Nevertheless, FINRA's position is that a single overseer such as itself would greatly benefit the market. "The ability to see activity across the markets is much better than a single exchange just seeing a part of it," Gira said.

The official indicated that a broker seeking to circumvent the rules could spread its trading out across several markets in order to make it harder for regulators to detect the wrongdoing. "Firms will try to fly under the radar by disaggregating their activity," Gira said.


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