FINRA Hunting for Those Trying to Game the Close

Trying to strong-arm the close may be back in fashion in some quarters. The Financial Industry Regulatory Authority says its surveillance unit is focusing on what it describes as efforts by some firms “to try to raise the price of [a] stock for marking” at the close of the trading day.

This is something “we are worried about, something we’re looking into,” said Thomas Gira, executive vice president and head of market regulation at FINRA. Gira spoke at an Investment Company Institute conference on Monday.

The concern is that reduced liquidity in the market as a result of the Securities and Exchange Commission’s recent ban on short sales in nearly 1,000 financial stocks may have prompted some firms to try “to set an artificial price” at the close, according to Gira. They may have done this by injecting a lot of volume into the market in the closing minutes. 

The SEC’s ban was in effect from Friday, September 19, through this past Wednesday, October 8. The short-selling ban caused some firms to stay out of the market in financial stocks as well as other names, reducing sell and buy liquidity across the board. Executives at the New York Stock Exchange and Nasdaq have publicly said this led to increased intraday volatility and dramatic moves in the closing minutes of trading.

Gira noted that there appeared to be some efforts to game the close in financial stocks in particular, which saw less volume because of the ban. He added that the stocks affected are not those that are extremely liquid, but those “farther down the list.”

This latest FINRA effort comes on the heels of several others related to short-selling. Gira noted that FINRA recently launched an investigation to probe potential links between trading in particular credit default swaps and short-selling activity in the underlying company’s stock. “We’ve reached out to 10 firms so far, [and] we’re looking at eight stocks in particular,” he said.

FINRA has also launched sweeps to look at how member firms “have complied with the [SEC’s] ban,” Gira said. The regulator is looking at what firms did with respect to the short-selling ban and the SEC’s T+3 rule, which requires firms to deliver shares for settlement of short sales or face severe penalties.

“We did see some pretty good processes in place,” Gira said, and the broker-dealer industry deserves credit for implementing policies during difficult market conditions on the fly. At the same time, FINRA is “looking for the mismarking of trades,” Gira said. In particular, it is scouting for trades that might not have been appropriately marked as short sales, and short sales that might not have been entitled to the ban’s exception. The SEC granted an exception to the short-selling ban to cash and derivatives market makers for short sales related to their market-making activity.

FINRA, NYSE Regulation, the SEC and the New York State Attorney General are also investigating potential instances of rumor-mongering that might have led firms spreading rumors about financial companies to profit from short-selling activity prior to the SEC ban. Gira said FINRA is “currently involved in a rumor sweep.” The regulator is examining the “policies and procedures firms have to prevent the circulation of sensational rumors,” he added.