Document ID: SEC-2013-1554-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2013-09-04T04:00Z

[Federal Register Volume 78, Number 171 (Wednesday, September 4, 2013)]
[Notices]
[Pages 54502-54504]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-21410]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70276; File No. SR-FINRA-2013-036]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change Relating to 
Wash Sale Transactions and FINRA Rule 5210 (Publication of Transactions 
and Quotations)

August 28, 2013.
    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 August 15, 2013, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I and 
II 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 add Supplementary Material .02 to FINRA Rule 
5210 (Publication of Transactions and Quotations) to emphasize that 
wash sale transactions are generally non-bona fide transactions and 
that members have an obligation to have policies and procedures in 
place to review their trading activity for, and prevent, wash sale 
transactions.
    Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *

5000. SECURITIES OFFERING AND TRADING STANDARDS AND PRACTICES

* * * * *

5200. QUOTATION AND TRADING OBLIGATIONS AND PRACTICES

5210. Publication of Transactions and Quotations

    No Change.
       Supplementary Material:
    .01 Manipulative and Deceptive Quotations. No Change.
    .02 Wash Sales. Transactions in a security that involve no change 
in the beneficial ownership of the security, commonly known as ``wash 
sales,'' generally are non-bona fide transactions for purposes of Rule 
5210. Members must have policies and procedures in place that are 
reasonably designed to review their trading activity for, and prevent, 
wash sale transactions. Transactions that originate from unrelated 
algorithms or separate and distinct trading strategies within the same 
firm would generally be considered bona fide transactions and would not 
be considered wash sales, even if the transactions did not result in a 
change of beneficial ownership, unless the transactions were undertaken 
for manipulative or other fraudulent purposes. Algorithms or trading 
strategies within the most discrete unit of an effective system of 
internal controls at a member firm are presumed to be related (e.g., 
within an aggregation unit, or individual trading desks within an 
aggregation unit separated by reasonable information barriers, as 
applicable). This Supplementary Material does not change members' 
existing obligations under NASD Rule 3010 and FINRA Rule 2010.
* * * * *

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

[[Page 54503]]

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
    FINRA is proposing to add supplementary material to FINRA Rule 5210 
to address members' obligations with respect to certain securities 
transactions that involve no change in the beneficial ownership of 
those securities, commonly known as ``wash sales.''
    With the recent increase in automated trading activity and the use 
of algorithms by firms to make trading decisions, FINRA has observed an 
increase in the number of transactions occurring where a single firm's 
proprietary trading account is on both sides of a trade, often as a 
result of a firm hitting its own bid or offer. Even if these 
transactions were not undertaken with fraudulent or manipulative 
intent, they can create a misimpression of the level of legitimate 
trading interest and activity in the security.
    FINRA recognizes that, in many situations, what may seem to be wash 
sale activity occurs as a result of orders that originate from the same 
firm, but from separate or distinct underlying trading strategies 
(e.g., separate ``desks,'' aggregation units, or algorithms) that have 
different--and sometimes competing--investment objectives and that 
deliberately do not interact with each other prior to generating orders 
to the market. Consequently, the proposed supplementary material does 
not seek to prevent all types of trading activity that happen to result 
from separate strategies operating within a single firm.
    The proposed supplementary material is intended to address wash 
sales occurring due to orders sent by a single algorithm or the 
unintended, but in FINRA's view preventable, interaction of multiple, 
related algorithms operated by a single firm. In a number of instances, 
FINRA has found that these types of transactions can account for a 
material percentage (e.g., over 5%) of the consolidated trading volume 
in a security on a particular day, which can distort the market 
information that is publicly available for that security. Even if not 
purposeful, these transactions can create the misimpression of active 
trading in a security that could adversely impact the price discovery 
process. Furthermore, in these instances it appears that firms will 
continue to allow this type of trading to occur rather than incur the 
costs necessary to prevent it, even though the trading activity is 
resulting in instances where significant misinformation may be 
disseminated to the marketplace.
    FINRA rules and the federal securities laws explicitly prohibit 
transactions in securities that do not result in a change of beneficial 
ownership in the securities when there is a fraudulent or manipulative 
purpose behind the trading activity.\3\ In addition, FINRA Rule 5210 
provides that no member may cause to be published or circulated any 
report of a securities transaction unless the member knows or has 
reason to believe that the transaction was a bona fide transaction. 
Supplementary Material .01 states that ``[i]t shall be deemed 
inconsistent with Rules 2010 (Standards of Commercial Honor and 
Principles of Trade), 2020 (Use of Manipulative, Deceptive or Other 
Fraudulent Devices) and 5210 (Publication of Transactions and 
Quotations) for a member to publish or circulate or cause to be 
published or circulated, by any means whatsoever, any report of any 
securities transaction or of any purchase or sale of any security 
unless such member knows or has reason to believe that such transaction 
was a bona fide transaction, purchase or sale.'' Consequently, each 
member has an existing obligation to know, or have a basis to believe, 
that transactions in which it participates are bona fide. Because wash 
sales generally are not bona-fide transactions, a member must review 
its trading activity to determine whether it is engaging in these types 
of transactions and make changes to minimize their occurrence.
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    \3\ See, e.g., 15 U.S.C. 78i(a)(1); FINRA Rule 6140(b).
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    Because of the increase in wash sale transactions noted above, 
FINRA is proposing to add Supplementary Material .02 to Rule 5210 to 
address specifically members' obligations with respect to wash sales 
that are occurring and being disseminated to the public when there is 
no fraudulent or manipulative motivation for the trading activity at 
issue.\4\ Specifically, proposed Supplementary Material .02 emphasizes 
that members have an obligation to have policies and procedures in 
place to review their trading activity for, and prevent, wash sale 
transactions. The proposed rule change, however, explicitly excludes 
those transactions that originated from unrelated algorithms or from 
separate and distinct trading strategies, provided these transactions 
are not undertaken for manipulative or other fraudulent purposes.\5\ 
The exclusion acknowledges the fact that some firms run multiple, 
separate algorithms or have trading desks that are separated by 
information barriers that, as a result of different or competing 
investment strategies within the same firm, may result in transactions 
where a single firm is on both sides of the trade. FINRA does not view 
these types of transactions as wash sales for purposes of Rule 5210, 
provided the trades are not undertaken with fraudulent or manipulative 
intent.
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    \4\ Securities transactions that do not result in a change of 
beneficial ownership of the securities and that are undertaken for 
the purpose of creating or inducing a false or misleading appearance 
of activity in the securities are already prohibited by existing 
securities laws and FINRA rules. See supra note 3.
    \5\ FINRA notes that transactions that originate from unrelated 
algorithms or from separate or distinct trading strategies, trading 
desks, or aggregation units that are frequent or numerous may raise 
a presumption that such transactions were undertaken with the intent 
that they cross and may, therefore, be intended as manipulative or 
fraudulent.
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    SEC Rule 200(f) provides that all traders within an ``aggregation 
unit'' must pursue only the particular trading objective or strategy of 
that aggregation unit and not coordinate that strategy with any other 
aggregation unit.\6\ It also provides that, at the time of each sale, 
each aggregation unit determine its net position for every security 
that it trades. Supplementary Material .02 provides that algorithms or 
trading strategies within the most discrete unit of an effective system 
of internal controls at a member firm (e.g., an aggregation unit, or 
individual trading desks within an aggregation unit separated by 
reasonable information barriers, as applicable), are presumed to be 
related.
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    \6\ See 17 CFR 242.200(f).
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    FINRA understands that not all wash sales, particularly those 
generated by trading algorithms, are avoidable. Consequently, only 
those firms that engage in a pattern or practice of effecting wash sale 
transactions that result in a material percentage of the trading volume 
in a particular security would generally violate Rule 5210, as well as 
Rule 2010. The proposed rule change requires reasonable policies and 
procedures and would not, therefore, apply to isolated wash sale 
transactions.\7\
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    \7\ FINRA notes that the proposed rule change would not change 
member firms' existing obligations under NASD Rule 3010 and FINRA 
Rule 2010 with respect to wash sales.
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    FINRA staff discussed the proposed rule change with several of its 
industry advisory committees in developing the approach reflected in 
the proposed rule change. Although these committees

[[Page 54504]]

recognized the problem FINRA was seeking to address and were generally 
supportive of the proposal, they indicated the need for FINRA to 
recognize that not all wash sales can be prevented. The proposed rule 
change explicitly includes language to exclude transactions that 
originated from unrelated algorithms or from separate and distinct 
trading strategies, trading desks, or aggregation units from being 
considered wash sales, provided these transactions are not undertaken 
for manipulative or other fraudulent purposes. The committees also 
requested guidance on whether the proposed rule change would apply to 
all wash sales or a subset. As noted above, only those firms that 
engage in a pattern or practice of effecting wash sale transactions 
that result in a material percentage of the trading volume in a 
particular security would generally violate Rule 5210, as well as Rule 
2010. The proposed rule change would not, therefore, apply to isolated 
wash sale transactions, provided the firm's policies and procedures 
were reasonable.
    As noted in Item 2 of this filing, 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 later than 60 days following publication of 
the Regulatory Notice announcing Commission approval. FINRA is 
providing firms with additional implementation time to ensure they have 
appropriate policies and procedures consistent with the proposed rule 
change.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\8\ 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. FINRA believes that the proposed rule change will 
reduce the number of wash sale transactions that, while not undertaken 
for manipulative or fraudulent purposes, nonetheless result in 
misinformation being disseminated to the marketplace and the public. 
FINRA believes that by requiring members to have reasonable policies 
and procedures in place to review for, and prevent, wash sales, the 
quality of market data will be enhanced, thus promoting just and 
equitable principles of trade and increasing the protection of 
investors and the public interest.
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    \8\ 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. Although some firms may need to 
enhance their written policies and procedures and, potentially, 
implement changes to technological systems to ensure compliance with 
the proposed rule change, FINRA believes these changes are necessary to 
enhance the quality of market data and will not significantly burden 
competition as any firm running multiple algorithms or operating 
multiple trading strategies will be subject to the same standard.

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

    Written comments were neither solicited nor received.

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 up to 90 days (i) as the 
Commission may designate 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-2013-036 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2013-036. 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 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-2013-036 and should be 
submitted on or before September 25, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-21410 Filed 9-3-13; 8:45 am]
BILLING CODE 8011-01-P