Document ID: SEC-2016-0322-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2016-02-24T05:00Z

[Federal Register Volume 81, Number 36 (Wednesday, February 24, 2016)]
[Notices]
[Pages 9235-9242]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-03794]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-77175; File No. SR-FINRA-2016-007]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Require 
Registration as Securities Traders of Associated Persons Primarily 
Responsible for the Design, Development or Significant Modification of 
Algorithmic Trading Strategies

February 18, 2016.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on February 11, 2016, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') (f/k/a National Association of Securities

[[Page 9236]]

Dealers, Inc. (``NASD'')) filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by FINRA. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to require registration as Securities Traders of 
associated persons primarily responsible for the design, development or 
significant modification of algorithmic trading strategies, or who are 
responsible for the day-to-day supervision or direction of such 
activities.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    NASD Rule 1032(f) (the ``Rule'') generally provides that each 
person associated with a member included within the definition of a 
representative must register with FINRA as a Securities Trader if, with 
respect to transactions in equity, preferred or convertible debt 
securities effected otherwise than on a securities exchange, such 
person is engaged in proprietary trading, the execution of transactions 
on an agency basis, or the direct supervision of such activities.\3\ 
This registration requirement currently does not reach associated 
persons that solely are involved in the design, development or 
significant modification of algorithmic trading strategies.
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    \3\ Before registration as a Securities Trader may become 
effective, an applicant must pass the Securities Trader 
qualification examination. A FINRA rule change establishing the 
Securities Trader registration category and qualification 
examination (which replaced the Equity Trader registration category 
and qualification examination) was approved by the SEC on August 28, 
2015. In this filing, FINRA also established a new principal 
registration category--Securities Trader Principal--for a principal 
with supervisory responsibility over securities trading activities. 
The effective date of the registration category and qualification 
examination requirement for Securities Traders and Securities Trader 
Principals was January 4, 2016. See Securities Exchange Act Release 
No. 75783, 80 FR 53369 (September 3, 2015) (Order Approving File No. 
SR-FINRA-2015-017); and Regulatory Notice 15-45 (November 2015). See 
also Securities Exchange Act Release No. 75394 (July 8, 2015), 80 FR 
41119 (July 14, 2015) (Notice of Filing of File No. SR-FINRA-2015-
017).
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    Given the prevalence of use of algorithmic trading strategies by 
members, and the resultant significant role such systems play in 
today's markets, FINRA proposes that associated persons primarily 
responsible for the design, development or significant modification of 
algorithmic trading strategies (or responsible for the day-to-day 
supervision or direction of such activities) be required to register as 
Securities Traders with FINRA and, thus, required to pass the requisite 
qualification examination and be subject to the same continuing 
education requirements as are applicable to individual securities 
traders. FINRA is concerned that problematic conduct stemming from 
algorithmic trading strategies, such as failure to check for order 
accuracy, inappropriate levels of messaging traffic, wash sales, 
failure to mark orders as ``short'' or perform proper short sale 
``locates,'' and inadequate risk management controls, could be reduced 
or prevented, in part, through improved education regarding securities 
regulations for the specified individuals involved in the algorithm 
design and development process.\4\
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    \4\ See Regulatory Notice 15-06 (Registration of Associated 
Persons Who Develop Algorithmic Trading Strategies) (March 2015), in 
which FINRA solicited comment on the proposed registration 
requirement.
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Scope of ``Algorithmic Trading Strategy''
    For purposes of the proposal, an ``algorithmic trading strategy'' 
is an automated system that generates or routes orders or order-related 
messages such as routes or cancellations, but does not include an 
automated system that solely routes orders received in their entirety 
to a market center. As markets change, the scope of what would be 
considered an algorithmic trading strategy will continue to evolve as 
new trading strategies are designed and developed.
    For example, FINRA has observed the following types of automated 
systems that would be included within the proposed definition of 
``algorithmic trading strategy:''
     An arbitrage strategy, such as index or exchange-traded 
fund (ETF) arbitrage;
     A hedging or loss-limit algorithmic strategy that 
generates orders on an automated basis;
     A strategy that involves simultaneously trading of two or 
more correlated securities due to the divergence in their prices or 
other trading attributes;
     An order generation, routing and execution program used 
for large-sized orders that involve dividing the order into smaller-
sized orders less likely to result in market impact;
     An order routing strategy used to determine the price or 
size for routed orders, the use of ``parent'' or ``child'' orders, or 
displayed versus non-displayed trading interest;
     A trading strategy that becomes more or less aggressive to 
correlate with trading volume in specified securities;
     A trading strategy that generates orders based on moving 
reference prices;
     A trading strategy that minimizes intra-day slippage in 
connection with achieving volume-weighted average prices and time-
weighted average prices; and
     A strategy that creates or liquidates baskets of 
securities, including those that track indexes or ETFs.
    The above is not an exhaustive list of the types of automated 
functionality that will be deemed an ``algorithmic trading strategy'' 
under the proposal. FINRA expects that members will register associated 
persons primarily responsible for the design, development or 
significant modification of automated programs (and day-to-day 
supervision or direction of such activities) that generate orders into 
the marketplace or execute trades without material intervention by any 
person. While NASD Rule 1032(f) currently is limited to activity 
effected otherwise than on a securities exchange, the proposed 
registration requirement applies to orders and order related messages 
whether ultimately routed (or sent to be routed) to an exchange or over 
the counter.
    For the purpose of this proposal, an order router alone would not 
constitute an algorithmic trading strategy; for example, a standard 
order router that routes retail orders in their entirety to a 
particular market center for handling and execution would not be 
considered an algorithmic trading strategy. If an order router performs 
any additional

[[Page 9237]]

functions, such as those set forth above, it would be considered an 
algorithmic trading strategy. In addition, an algorithm that solely 
generates trading ideas or investment allocations, including an 
automated investment service that constructs portfolio recommendations, 
but that is not equipped to automatically generate orders and order-
related messages to effectuate such trading ideas into the market 
(whether independently or via a linked router), would not constitute an 
algorithmic trading strategy for purposes of the proposal.
Scope of Registration Requirement
    FINRA developed the proposed registration requirement to address 
concerns around the role of algorithmic trading strategies in 
problematic marketplace conduct by member firms. Pursuant to the 
proposal, associated persons primarily responsible for the design, 
development or significant modification \5\ of algorithmic trading 
strategies (or responsible for the day-to-day supervision or direction 
of such activities) would be required to take a qualification 
examination and be subject to continuing education requirements. As 
noted above, FINRA published Regulatory Notice 15-06 to solicit comment 
on the proposed registration requirement. FINRA received feedback from 
members, including requesting clarification and guidance on FINRA's 
expectations around supervision, and registration of supervisors, in 
connection with the proposal.\6\ The majority of these questions and 
concerns focused on firm personnel not currently required to register 
pursuant to the Rule. For example, while an equity trader involved in 
the design of an algorithmic trading strategy already would be required 
to register pursuant to NASD Rule 1032(f), the developer with which the 
trader collaborates to create an algorithmic trading strategy may not 
be. Members have inquired whether, in such cases, the registration 
requirement would extend to other coders on the development team or 
persons higher in the developer's reporting line.
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    \5\ A ``significant modification'' to an algorithmic trading 
strategy generally would be any change to the code of the algorithm 
that impacts the logic and functioning of the trading strategy 
employed by the algorithm. Therefore, for example, a data feed/data 
vendor change generally would not be considered a ``significant 
modification,'' whereas a change to a benchmark (such as an index) 
used by the strategy generally would be considered a ``significant 
modification.''
    FINRA notes that, even in cases where a modification is not 
significant and, therefore, would not be required to be performed by 
a registered Securities Trader pursuant to this proposal, as stated 
in Regulatory Notice 15-09, firms should also focus efforts on the 
development of algorithmic strategies and on how those strategies 
are tested and implemented, including, among other things, 
implementing a change management process that tracks the development 
of new trading code or material changes to existing code. An 
effective process should include a review of test results and a set 
of approval protocols that are appropriate given the scope of the 
code or any change(s) to the code. See Regulatory Notice 15-09 
(Guidance on Effective Supervision and Control Practices for Firms 
Engaging in Algorithmic Trading Strategies) (March 2015).
    \6\ See supra note 4. The comments and FINRA's response are 
discussed in Item II.C. below.
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    While workflows, structures and roles may differ across members, in 
proposing this amendment, FINRA seeks to ensure that members identify 
and register associated persons primarily responsible for the design, 
development or significant modification of algorithmic trading 
strategies (or responsible for the day-to-day supervision or direction 
of such activities). In establishing this requirement, FINRA seeks to 
ensure that one or more associated persons that possess knowledge of, 
and responsibility for, both the design of the intended trading 
strategy (e.g., the arbitrage strategy) and the technological 
implementation of such strategy (e.g., coding), sufficient to evaluate 
whether the resultant product is designed not only to achieve business 
objectives, but also regulatory compliance. As stated in Regulatory 
Notice 15-06, FINRA does not intend the registration requirement to 
apply to every associated person that touches or otherwise is involved 
in the design or development of a trading algorithm.
    For example, if a sole associated person determines the design of 
the trading strategy employed by an algorithm, writes the code to 
effectuate such strategy, and executes or directs the modification of 
such code going forward, then that person alone would be required to 
register as a Securities Trader under the proposal.\7\
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    \7\ It is understood that various technology and other firm 
personnel are involved in additional tasks necessary to launch an 
algorithmic trading strategy into production--such as integrating 
the algorithm into the firm's technological infrastructure and 
testing linkages. However, because these activities generally would 
not be considered to be design, development or significant 
modification activities with respect to the algorithm itself, 
registration of such personnel as Securities Traders would not be 
required pursuant to this proposal.
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    In contrast, where a lead developer liaises with a head trader 
regarding the head trader's desired algorithmic trading strategy, and 
is primarily responsible for the supervision of the development of the 
algorithm to meet such objectives, such lead developer must be 
registered under the proposal as the associated person primarily 
responsible for the development of the algorithmic trading strategy and 
supervising or directing the team of developers. Individuals under the 
lead developer's supervision would not be required to register under 
the proposal if they are not primarily responsible for the development 
of the algorithmic trading strategy or are not responsible for the day-
to-day supervision or direction of others on the team.\8\ Under this 
scenario, the person on the business side that is primarily responsible 
for the design of the algorithmic trading strategy, as communicated to 
the lead developer, also would be required to register (if not already 
required to register as a Securities Trader due to their other duties). 
In the event of a significant modification to the algorithm, members, 
likewise, must ensure that the associated person primarily responsible 
for the significant modification (or the associated person supervising 
or directing such activity), is registered as a Securities Trader.\9\
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    \8\ For example, a junior developer on the lead developer's team 
presumably is not ``primarily'' responsible for the design, 
development or significant modification of an algorithmic trading 
strategy and, therefore, would not be required to register under the 
proposal. By limiting the registration requirements to those persons 
primarily responsible for the design, development or significant 
modification of algorithmic trading strategies (or responsible for 
the day-to-day supervision or direction of such activities) FINRA 
aims to ensure that the member has identified the individuals 
primarily responsible for covered activities, and for the day-to-day 
supervision and direction of covered activities, and equip them with 
a basic level of familiarity with the regulatory obligations of the 
firm employing the algorithm. FINRA expects that the competency of 
these associated persons will inform the behaviors of those acting 
under their supervision or at their direction.
    \9\ In certain cases, the design of a new algorithmic trading 
strategy (or significant modification to an existing strategy) may 
be originated and approved by a committee within the firm, including 
by committee members whose roles may be unrelated to trading or 
development (e.g., sales personnel providing insight regarding 
client needs or research analysts regarding sector trends). In such 
cases, FINRA would not consider each committee member to be 
primarily responsible for the design or significant modification of 
the algorithmic trading strategy, so long as an appropriately 
registered associated person is designated as primarily responsible 
for defining the business requirements of the trading strategy to be 
employed by the algorithm.
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    To clarify the scope of the proposed requirement, the proposed rule 
provides that only those persons involved in the ``day-to-day'' 
supervision or direction of the activities covered by this proposal 
would be required to register. Thus, each person associated with a 
member must register as a Securities Trader if such person is (i) 
primarily responsible for the design, development or significant 
modification of an

[[Page 9238]]

algorithmic trading strategy relating to equity (including options), 
preferred or convertible debt securities; or (ii) responsible for the 
day-to-day supervision or direction of such activities.\10\
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    \10\ As discussed further below, a senior or lead developer's 
supervisor would not necessarily be required to be registered under 
the proposal if that person is not involved in the day-to-day 
supervision or direction of the development process.
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    FINRA notes that FINRA Rule 3110(a)(2) generally requires that all 
registered persons be designated to an appropriately registered 
principal or principals with authority to carry out the supervisory 
responsibilities of the member for each type of business in which it 
engages for which registration as a broker-dealer is required. With the 
addition of this new activity to the Securities Trader registration 
category, members will be required to designate developers to a 
registered principal for Rule 3110(a)(2) purposes. In such instances, 
FINRA believes it is appropriate that members may ``assign'' a lead 
algorithm developer (or other non-trader) engaging in covered 
activities to one or more other registered persons of the member that 
supervise trading activities outside such developer's or other non-
trader's usual reporting line.
    While the adequacy of a member's supervisory structure must be 
evaluated on an individual firm basis, members are afforded a degree of 
flexibility in arranging for the appropriate supervision of a lead 
developer (or other non-trader) that engages in covered activities, 
such as by assigning such person to:
     A Securities Trader Principal \11\ in the member's trading 
business line (e.g., the Securities Trader Principal in the reporting 
line of a Securities Trader primarily responsible for the design of any 
algorithmic trading strategy); or
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    \11\ To qualify for registration as a Securities Trader 
Principal, an individual must be registered as a Securities Trader 
(Series 57) and pass the General Securities Principal qualification 
examination (Series 24). See supra note 3.
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     A Securities Trader in the member's trading business line 
(e.g., a Securities Trader primarily responsible for the design of an 
algorithmic trading strategy, including the strategy developed by the 
lead developer); or
     More than one registered person, provided that the 
supervisor responsible for the lead algorithm developer's activities 
requiring registration as a Securities Trader must be registered as a 
Securities Trader or Securities Trader Principal.\12\
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    \12\ Another registered person--e.g., a General Securities 
Representative--may be assigned to supervise the lead algorithm 
developer with regard to other general areas applicable to 
registered reps, such as outside business activities.
    As always, if the activities of a registered representative are 
assigned to be supervised by more than one registered representative 
or principal, the member must clearly document which activities are 
assigned to be supervised by each responsible party.

Accordingly, the proposal may not necessarily trigger registration 
requirements for the current supervisor of algorithm design or 
development personnel if such supervisor is not responsible for the 
day-to-day supervision or direction of the specific activities covered 
by this proposal. However, the firm must designate an appropriately 
registered person to be responsible for supervising the algorithmic 
trading strategy activities.
Third-Party Algorithms
    In some cases, an algorithmic trading strategy employed by a member 
may not have originated in-house and, therefore, may not have been 
designed or built by the member's associated persons. In cases where 
the design and development of an algorithmic trading strategy was 
performed solely by a third-party, the proposed registration 
requirement would not apply to the member with regard to the design or 
development of such algorithm. However, FINRA notes that, to the extent 
associated persons were involved in the design or development, or are 
able to significantly modify the algorithmic trading strategy in-house, 
such persons must be registered as Securities Traders.\13\
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    \13\ See supra note 5.
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    A member also may engage a third-party to custom-build an 
algorithmic trading strategy for the member. In such cases, the 
associated person responsible for directing the third-party in the 
design, development or significant modification of the algorithmic 
trading strategy also would be included within the scope of this 
proposal and must be registered as a Securities Trader. Similarly, 
after the member has launched the externally built algorithm, any 
significant modification by the member to such algorithm must be 
performed by a registered Securities Trader.
    FINRA notes that, irrespective of whether an algorithm is designed 
or developed in-house or by a third-party, the member employing the 
algorithm continues to be responsible for the algorithm's activities. 
Thus, in all cases, robust supervisory procedures, both prior to and 
after deployment of an algorithmic trading strategy, are a key 
component in protecting against problematic behavior stemming from 
algorithmic trading.\14\ In addition, as is the case under the current 
rules, associated persons responsible for monitoring or reviewing the 
performance of an algorithmic trading strategy must be registered 
pursuant to NASD Rule 1032(f); a member's trading activity must always 
be supervised by an appropriately registered person. Therefore, even 
where a firm purchases an algorithm off-the-shelf and does not 
significantly modify the algorithm, the associated person responsible 
for monitoring or reviewing the performance of the algorithm must be 
registered pursuant to NASD Rule 1032(f).
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    \14\ See Regulatory Notice 15-09 (Guidance on Effective 
Supervision and Control Practices for Firms Engaging in Algorithmic 
Trading Strategies) (March 2015).
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    As noted in Item 2 of this filing, if the Commission approves the 
proposed rule change, FINRA will announce the effective date of the 
proposed rule change in a Regulatory Notice to be published no later 
than 60 days following Commission approval. The effective date will be 
no sooner than 180 days following publication of the Regulatory Notice 
but no later than 300 days following Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\15\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest.
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    \15\ 15 U.S.C. 78o-3(b)(6).
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    The prevalence of use of algorithms in the marketplace has 
highlighted the risks that arise when such strategies are poorly 
designed. FINRA has observed situations in which algorithmic trading 
strategies have resulted in manipulative trading activities and 
potential securities law violations, including of SEC Regulation NMS, 
SEC Regulation SHO, SEA Rule 15c3-5 and other critical market and 
investor protection safeguards. This proposal requires associated 
persons primarily responsible for the design, development or 
significant modification of an algorithmic trading strategy (or 
responsible for the day-to-day supervision or direction of such 
activities) to meet a minimum standard of knowledge regarding the 
securities rules and regulations applicable to the member employing the 
algorithmic trading strategy that is identical to the

[[Page 9239]]

standard of knowledge applicable to traditional securities traders.
    FINRA believes that problematic market conduct may be reduced 
through improved education of firm personnel regarding securities 
regulations. FINRA also believes that the proposal will help clarify 
members' obligations with respect to FINRA's expectations regarding 
associated persons primarily responsible for the design, development or 
significant modification of algorithmic trading strategies (or 
responsible for the day-to-day supervision or direction of such 
activities). Thus, FINRA believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\16\ in 
that it is designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest.
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    \16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.
Economic Impact Assessment
Need for the Rule
    FINRA is concerned that associated persons primarily responsible 
for the design, development or significant modification of algorithmic 
trading strategies (or who are responsible for the day-to-day 
supervision or direction of such activities) may lack adequate 
knowledge regarding the securities rules and regulations applicable to 
FINRA members operating in the securities markets. This lack of 
knowledge could result in algorithms that do not comply with applicable 
rules. As noted above, FINRA has observed situations in which 
algorithmic trading strategies have resulted in manipulative trading 
activities and potential securities law violations. Further, FINRA 
notes that, under the current regulatory structure, some individuals 
primarily responsible for the design, development or significant 
modification of algorithmic trading strategies (or who are responsible 
for the day-to-day supervision or direction of such activities) may 
claim that they are not required to be aware of the firms' 
responsibilities under applicable securities rules and regulations. The 
proposed rule would close this gap in regulatory oversight.
    The proposed rule change is intended to enhance investor protection 
by limiting the development of algorithms designed in conflict with 
securities rules and regulations. The proposal may also reduce 
uncertainty by certain market participants of their obligations. It 
aims to do so through a registration requirement and improved education 
regarding securities regulations for specified individuals involved in 
the algorithm design and development process.
Economic Baseline
    The registration requirements for associated persons under current 
FINRA rules serve as an economic baseline of the proposed rule change. 
Currently, associated persons that solely are primarily responsible for 
the design, development or significant modification of an algorithmic 
trading strategy (or who are responsible for the day-to-day supervision 
or direction of such activities) are not required to register with 
FINRA as Securities Traders. The economic impacts of the proposal 
depend on the number of additional individuals that would be covered by 
the proposed registration requirement.
    Pursuant to the proposed rule change, associated persons primarily 
responsible for the design, development or significant modification of 
algorithmic trading strategies (or responsible for the day-to-day 
supervision or direction of such activities) would be required to 
register as Securities Traders with FINRA. Under current FINRA rules, 
it is likely that many of the associated persons primarily responsible 
for the design of algorithmic trading strategies already are 
registered, assuming that they also engage in traditional trading 
activities. Associated persons primarily responsible for the 
development of algorithmic trading strategies are likely not 
registered. With regard to supervisors, as noted above, FINRA believes 
it appropriate for members to ``assign'' a lead algorithm developer 
engaging in covered activities to certain registered persons 
supervising trading activities outside such developer's usual reporting 
line. Therefore, many of the associated persons responsible for the 
day-to-day supervision or direction of the design, development or 
significant modification of algorithmic trading strategies may have 
already registered.
    In Regulatory Notice 15-06, FINRA sought comment on the number of 
persons who conduct activity that may be covered by the proposed rule 
change, but did not receive any quantitative estimates. Given the 
diverse nature of the activity and organizational structures among 
firms, it is not possible for FINRA to accurately estimate the number 
of persons who are primarily responsible for the design, development or 
significant modification of algorithmic trading strategies. FINRA is, 
however, aware of anecdotal information that suggests that these 
activities represent significant numbers of personnel for some firms. 
Currently, some firms may be organized such that the covered activities 
are supervised by a registered person, but in other cases the 
activities are managed separately.
Economic Impacts
    The proposed rule change is expected to enhance investor protection 
and member compliance by limiting problematic conduct stemming from 
algorithmic trading strategies. It should also reduce uncertainty by 
certain market participants of their obligations.
    FINRA recognizes that the proposal would impose costs on member 
firms employing associated persons engaged in the activity subject to 
the registration requirement. Specifically, among other things, 
additional associated persons would be required to become registered 
under the proposal, and the firm would need to establish policies and 
procedures to monitor compliance with the proposed requirement on an 
ongoing basis. In Regulatory Notice 15-06, FINRA solicited public 
comment on the estimated number of member firms that would be affected 
by the proposal, the estimated number of associated persons not 
currently required to register as Securities Traders that would be 
covered by the proposal, and the estimated costs associated with 
monitoring compliance with the proposed requirement. FINRA did not 
receive any estimates of these metrics. As discussed above, FINRA 
expects that most of the costs would be related to the registration and 
continuing education requirements for associated persons primarily 
responsible for the design, development or significant modification of 
algorithmic trading strategies. Some of the costs may be passed on to 
the associated persons depending on member firm policies regarding 
examination and examination preparation costs.
    The proposal also may have indirect impacts on member firms. For 
example, it may discourage persons not currently required to register 
as Securities Traders, such as some algorithm developers, from 
associating with a member firm in a capacity that requires 
registration.
    However, given the prevalence and importance of algorithmic trading 
strategies in today's markets, FINRA

[[Page 9240]]

believes that associated persons engaged in the activities covered by 
this proposal must meet a minimum standard of knowledge regarding the 
applicable securities rules and regulations. To mitigate the costs 
imposed on member firms, the proposed rule change limits the scope of 
registration requirement by excluding technological or development 
support personnel who are not primarily responsible for the covered 
activities. It also excludes supervisors who are not responsible for 
the ``day-to-day'' supervision or direction of the covered activities. 
Moreover, FINRA believes that it is appropriate for firms to ``assign'' 
lead algorithm developers or other non-traders engaging in covered 
activities to certain supervisors that are existing registered persons.
Alternatives Considered
    As discussed in the Statement on Comments below, FINRA considered 
in-house training of firm personnel as an alternative to the proposed 
registration and qualification requirements. FINRA also considered 
whether another existing examination would be as (or more) appropriate 
than the Securities Trader qualification examination. FINRA believes 
that the proposed registration and continuing education requirements 
are best suited for associated persons engaging in covered activities.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    On March 19, 2015, FINRA published Regulatory Notice 15-06 
soliciting comment on the proposed registration of associated persons 
primarily responsible for the design, development or significant 
modification of an algorithmic trading strategy, or who are responsible 
for supervising or directing such activities. The comment period 
expired on May 18, 2015, and FINRA received six comment letters.\17\ 
Three comment letters generally support the goal sought to be advanced 
by FINRA's proposal--i.e., to help prevent securities law violations 
from occurring through use of algorithmic trading strategies, though 
some commenters suggest alternatives to the proposed approach or 
request clarifications.\18\
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    \17\ Letter from John Ramsay, Chief Market Policy Officer, IEX 
Services LLC, to Marcia E. Asquith, Corporate Secretary, FINRA, 
dated May 5, 2015 (``IEX''); letter from Abe Kohen, President, AK FE 
Consultants, LLC, to Marcia E. Asquith, Corporate Secretary, FINRA, 
dated May 15, 2015 (``AK FE Consultants''); letter from Mary Ann 
Burns, Chief Operating Officer, FIA Principal Traders Group, to 
Marcia E. Asquith, Corporate Secretary, FINRA, dated May 18, 2015 
(``FIA PTG''); letter from Michael Hinel, Law Student Clinician, 
Michigan State University College of Law, to Marcia E. Asquith, 
Corporate Secretary, FINRA, dated May 18, 2015 (``Michigan State); 
letter from Tom C.W. Lin, Associate Professor of Law, Temple 
University Beasley School of Law, to Marcia E. Asquith, Corporate 
Secretary, FINRA, dated May 18, 2015 (``Temple''); and letter from 
Richard J. McDonald, Chief Regulatory Counsel, Susquehanna 
International Group, to Marcia E. Asquith, Corporate Secretary, 
FINRA, dated May 18, 2015 (``SIG'').
    \18\ AK FE Consultants' letter seems to misunderstand the scope 
of the proposed registration requirement as reaching to consultant 
developers that are not associated persons. As noted above, the 
current proposal applies to persons associated with a member firm.
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Scope of ``Algorithmic Trading Strategy''
    IEX requests clarification on the rule's application to different 
types of order routers; particularly treatment of smart order routers 
that route orders received from customers, but may break the order into 
``child'' orders. IEX states that it would not object to the coverage 
of such routers, but requests clarification as to the proposal's 
intended scope with respect to these routers. FINRA confirms that a 
smart order router that breaks orders into ``child'' orders is within 
the scope of ``algorithmic trading strategy'' as contemplated in this 
proposal.
    FIA PTG proposes expanding the types of systems that would fall 
within the scope of the Rule to include strategies that are not fully 
automated. FIA PTG believes that partially automated strategies may 
present the same potentially problematic issues as fully automated 
strategies. Thus, FIA PTG recommends that the proposal apply to persons 
engaged in the development of ``automated trading functionality'' 
rather than ``algorithmic trading strategies.'' FIA PTG believes this 
broader term--automated trading functionality--would better capture 
examples of both professional and retail trading systems that offer 
automated features, such as automation of order book sensitive pricing, 
automatic short order locate and marking logic, automation of trade 
timing based on moving reference prices, and automation of hedging or 
loss-limit orders among other software features.
    FINRA does not believe it is appropriate at this time to modify the 
proposal as suggested by FIA PTG. FINRA believes that it is appropriate 
initially to focus the scope of the Rule on systems equipped to engage 
in activity that could potentially result in securities law violations 
and, thus, has limited the scope of the proposal to automated systems 
that generate or route orders (or order-related messages), but does not 
include automated systems that solely route orders received in their 
entirety to a market center. FINRA also determined to focus the 
proposal on the covered activities (design, development and significant 
modification activities, and the day-to-day supervision or direction of 
such) to the extent that there was no material human intervention. 
Therefore, partially automated strategies would not fall within the 
proposal's scope (unless such systems otherwise met the definition of 
``algorithmic trading strategy'' as discussed herein). Finally, FINRA 
believes that some of the functionality described by FIA PTG--e.g., 
automation of trade timing based on moving reference prices and 
automation of hedging or loss-limit orders--may currently fall within 
the scope of the proposal and, therefore, would be covered. FINRA will 
further consider whether the scope of the Rule should be broadened to 
cover a wider range of systems once experience has been gained with the 
proposed narrower scope.
Scope of Application to Supervisors
    IEX notes that, as drafted, the proposal applies to persons (i) 
primarily responsible for the design, development or significant 
modification of an algorithmic trading strategy or (ii) responsible for 
supervising or directing such activities. IEX suggests that the second 
prong should be revised to cover persons responsible for the ``day-to-
day'' supervision or direction of such activities, to more clearly 
reflect the proposal's intended scope. FINRA agrees that the proposal 
is intended to capture only those involved in the day-to-day 
supervision or direction of the covered activities, and has revised the 
proposed rule text to reflect this change.
Impact on Technology Professionals Associated With Member Firms
    FIA PTG states that it agrees with FINRA's view that support 
personnel should not be required to register. FIA PTG argues that, in 
addition to excluding technological or development support personnel 
who are not primarily responsible for the covered activities, FINRA 
also should exclude users of software, researchers, infrastructure 
developers, hardware technicians, and operations development staff.
    FINRA does not believe modification of the proposal is necessary. 
Particularly, to the extent that an associated person's activities are 
limited to using software in a manner that does not amount to engaging 
in the covered activities, FINRA believes the proposal already is clear 
that such persons would

[[Page 9241]]

not be covered. In the case of the other types of personnel FIA PTG 
references by general job category (e.g., infrastructure developers), 
FINRA notes that an assessment of such persons' activities with respect 
to algorithms should govern whether they are captured by the proposal, 
rather than a wholesale exemption based on a general job category.
    SIG believes that a registration requirement would discourage well-
qualified developers from participating in the development of 
algorithmic trading strategies and affiliating with FINRA member firms, 
which SIG states would be broadly and materially counter-productive and 
may result in less market stability due to less qualified developers 
building algorithms. Similarly, FIA PTG notes that any time a 
registration requirement is not reasonably related to the role or 
expectations of a professional, it becomes an impediment to hiring and 
retention. However, FIA PTG also notes that the impact can be mitigated 
by avoiding prescriptive definitions, and allowing firms to use 
discretion when identifying the individuals who would require 
registration.
    FINRA is sensitive to the impact of the proposal on persons not 
currently required to register pursuant to NASD Rule 1032(f). However, 
given the important role that certain associated persons play in the 
ultimate trading activities engaged in by member firms through the 
employment of algorithms, FINRA continues to believe it is important to 
balance the concerns raised by FIA PTG and SIG with the goal of 
facilitating compliance with critical market and investor protection 
rules and, thus, has focused the scope of the proposal on those 
associated persons primarily responsible for the design development and 
significant modification of algorithmic trading strategies (and those 
responsible for the day-to-day supervision and direction of such 
activities), rather than entire departments or general job functions. 
As suggested by FIA PTG, FINRA's proposal places within the 
responsibility of each member the task of identifying the individual or 
individuals primarily responsible for the activities covered by the 
proposal and, thus, avoids overbroad application of the Rule.
Alternatives to a FINRA Registration Requirement
    SIG disagrees that a FINRA registration requirement would be 
effective in preventing algorithm trading strategies that result in 
improper activities or securities law violations. SIG believes that 
robust systems controls are the most effective means of preventing the 
concerns raised; however, additional efforts suggested include training 
of technology staff, including a continuing education component 
(without a registration requirement), and chaperoning requirements for 
non-registered personnel. Michigan State supports the proposal and 
believes that it strikes an appropriate balance and will effectively 
promote both investor protection and market integrity.\19\
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    \19\ Temple somewhat supports the proposal, but suggests that 
the registration requirement be more firm-focused than person-
focused, so that the firms with the most potential market impact 
would be required to register. FINRA disagrees, and believes that 
all persons covered by a registration category should be 
appropriately qualified.
    Temple also suggests that, in light of the rapid pace of 
financial innovation and technology, proposed rule initiatives 
should be structured as pilots, having sunset provisions, or other 
time-sensitive mechanisms to help support the goal of rules that are 
reflective of the marketplace. FINRA does not believe the 
registration requirement should be implemented on a pilot basis, and 
notes that registration requirements and accompanying examinations 
remain reflective of the marketplace on an ongoing basis through 
regular review of examination content outlines and continuing 
educational requirements.
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    FINRA agrees that robust systems controls are a critical component 
in any discussion around the regulation of algorithmic trading. 
However, education of those responsible for the creation of an 
algorithmic trading strategy is a separate and equally important 
consideration. For example, even if an algorithm never malfunctions 
from a technological standpoint, its behavior nonetheless may violate 
securities laws if appropriate constraints were not built into the 
design and development phases that ensure any order generated by the 
algorithm observes applicable regulatory standards (e.g., entry of only 
bona fide orders) and incorporates necessary related tasks (e.g., short 
order marking and performing locates). In addition, while in-house 
training of firm personnel is important, FINRA does not believe it is a 
suitable substitution for registration and qualification in the area of 
securities trading.\20\
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    \20\ FIA PTG supports a FINRA registration requirement, but 
requests that a broader range of examinations be considered 
acceptable for purposes of the proposal, such as the Series 7. FINRA 
has considered whether another existing examination would be as (or 
more) appropriate than the Series 57, as well as whether a new 
examination should be created for this purpose, and continues to 
believe that, at this time, the Securities Trader registration 
category is best suited to educate associated persons that engage in 
the activities covered by the proposal.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2016-007 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2016-007. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such

[[Page 9242]]

filing also will be available for inspection and copying at the 
principal office of FINRA. All comments received will be posted without 
change; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to File Number 
SR-FINRA-2016-007 and should be submitted on or before March 16, 2016.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-03794 Filed 2-23-16; 8:45 am]
BILLING CODE 8011-01-P