FREE email newsletters 
Insider Trading Surveillance to Get Overhauled
Traders Magazine Online News, April 10, 2008
Market surveillance for insider trading will soon be consolidated by listing market. For the first time, each listing market will be responsible for market surveillance for all trading in its listed names across venues.
Nasdaq said the impending change is the consequence of the fragmentation of listed trading. It's "due in part to the Securities and Exchange Commission's determination of a perceived gap largely driven by Nasdaq's increasing market share in NYSE and NYSE Arca-listed equity securities," Nasdaq wrote in connection with a rule filing about a related regulatory topic in February.
This change means NYSE Regulation and the Financial Industry Regulatory Authority will likely conduct all market surveillance. NYSE Reg, a not-for-profit subsidiary of NYSE Euronext, already conducts market surveillance for all NYSE and NYSE Arca trading. NYSE Euronext is in the process of acquiring the American Stock Exchange. Nasdaq outsources its market surveillance to FINRA.
"It seems logical to do this and to prevent the duplication of efforts by continuing the split-up of the regulatory responsibilities between two organizations, each of whom is capable of doing the job well," said Andrew Klein, a partner at law firm Schiff Harden. Klein, co-leader of the firm's securities and futures regulation group, was the director of the SEC's Division of Market Regulation (now called Trading and Markets) during the 1970s.
FINRA and NYSE Reg "have ample tools and funds," Klein said. "They're looked to by the Commission as the primary guardians of the gate."
Self-regulatory organizations are currently responsible for the intraday market surveillance of trading on their venues. However, the primary listing market has historically been the main party responsible for intraday surveillance in its listed names, according to Onnig Dombalagian, a professor at Tulane Law School who has written extensively about self-regulatory organizations. Consequently, he said, "it would probably be a modest benefit to have the listing exchange be responsible exclusively for all trading activity with respect to its listed securities."
However, Dombalagian noted that the fragmentation of trading has recently made surveillance more complex than it previously was. "With fragmentation, surveilling trading is more difficult because the listing market doesn't necessarily have enough information--such as the underlying details of transactions effected on other markets by nonmembers--to make inquiries of other SROs or refer cases to the SEC," Dombalagian said.
"If Nasdaq's automated marketplace manages to snag significant volume in NYSE-listed trading," he explained, "NYSE Reg may not pick up, through its normal review of transaction reports and underlying execution details, anomalous trading activity [that takes place elsewhere]." Dombalagian noted that Nasdaq as an SRO has an obligation to surveil its own trading, but that it may also rely on the Big Board's extensive efforts to surveil the market in NYSE-listed trading.
"So it makes sense that the listing exchange, to the extent it bears responsibility for surveilling the market, would want to have exclusive authority across all trading centers," Dombalagian added.
The impending shift in surveillance responsibilities is designed to make regulatory oversight and surveillance for insider trading more uniform and efficient across displayed markets by consolidating it in the hands of the listing market. According to a November report from the Government Accountability Office, the SEC's Office of Compliance Inspections and Examinations found last year that there was duplication of surveillance efforts by SROs and variances in the alerts generated by SROs monitoring trading in the same securities.
For more information on related topics, visit the following channels:
