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December 1, 2011

IOI Proposal Draws Mixed Reviews

By Peter Chapman

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  • IOI Proposal Draws Mixed Reviews

A rule proposed by the Financial Industry Regulatory Authority that could limit broker-dealers' usage of indications of interest drew mixed reviews from those who submitted comment letters to the regulator.

Brokers and their advocates shot down the proposal, while one major buyside shop praised FINRA. While respondents differed on the rule's impact on buyside-sellside relations, both sides managed to find some common ground.

James Toes

"The STA is opposed to this amendment," James Toes, president and chief executive of the Security Traders Association, told FINRA in its letter. "Rather than clearing up a perceived issue emanating from a small subset of the marketplace, this amendment would build a wall between market participants."

In favor of the change was Capital Research and Management Company, a large money manager based in Los Angeles. Saying he supported the "broad intent" of the rule, Matt Lyons, the firm's global trading manager, urged FINRA to fine-tune it. Capital Research "applauds the ongoing work of FINRA to improving the quality and clarity between member firms and their customers," Lyons said.

At issue is a proposed amendment to Rule 5210, published last month, that attempts to bar brokers from sending out IOIs labeled as "natural" if they aren't backed by an actual customer order.

In its proposal, FINRA said it was concerned that brokers were disseminating misleading information regarding IOIs, including not accurately labeling them to reflect their origination.

The proposal addresses buyside complaints that some IOIs they receive are mislabeled. They're called "naturals," but, in fact, are not associated with an actual order. There may be no order, or the "order" may, in fact, be a broker's proprietary position.

The proposal is the third time in the past five years that FINRA has addressed the problem. In both September 2006 and May 2009, FINRA (or its predecessor NASD) sent out notices to its members reminding them to be "truthful" when using IOIs.

The warnings apparently weren't enough for some.

"While we believe the 2009 notice was helpful, we received a number of comments from our committees and otherwise that without a clear definition of a natural IOI, there is still potential for misuse," FINRA president and chief executive officer Rick Ketchum said at a recent industry conference. "Namely, when the buyside trader attempts to reach out to a natural IOI, he finds there is no longer any trading interest behind it."

Most IOIs are not labeled as "naturals," according to a vendor who distributes the trade advertisements for brokers. "Many broker-dealer firms disseminate hundreds of thousands of IOIs daily while marking only a few hundred or less as natural IOIs," Raptor Trading Systems' Nasser Sharara told FINRA.