Firms engaged in algorithmic trading strategies may wish to have their Chief Compliance Officer register as a Securities Trader or Securities Trader Principal.
June 2016 the SEC approved an amendment expanding the scope of persons required to register as “Securities Trader” as it pertains to firms engaged in Algorithmic Trading Strategy. Rule amendment 16-21 applies to persons who supervise day-to-day activities or who are primarily responsible for design, development, or significant modification to algorithm systems. The rule is intended to ensure persons associated with these functions possess knowledge or and responsibility for the design and the intended trading strategy, as well as technological implementation. This registration requirement is expected to ensure system changes are designed with regulatory compliance in mind as well as business objectives.
The anticipated amendment comes on the heels of the Securities Trader designation established in January 2016 where Series 57 Securities Trader category replaced Series 55 Equity Trader Registration. Series 57 qualification was adopted to fold Floor Traders and High-Frequency-Traders “HFTs” and others who were previously exempt from registration status into FINRA oversight. Specifically “Floor Traders” whom used to be exempt are now subject to broker-dealer policies and procedures, risk management, as well as SRO “Self Regulating Organization” review. The examination qualifies persons who execute trades on electronic marketplaces such as; NASDAQ, OTCBB; and OTC and Options trades executed on the CBOE. Suffice it to say, HFTs and Floor Traders are scrambling to bring their business model up to broker dealer compliance regulations.
Read Regulatory Notice 16-21 Qualification and Registration of Associated Persons Relating to Algorithmic Trading
RND Resources assists Broker Dealer firms with implementing regulatory compliance and provides support services such as; updates to procedures & policies, Internal Controls, FinOp or CCO Principal Registration, CyberSecurity testing & governance, and more.
Dave Banerjee, CPA – Regulatory Compliance Consultant and Co-founder of RND Resources has the requisite Registrations for Securities Trader Principal (Series 55 – now 57 – and Series 24). Feel free to reach out us for a quote on Securities Trader Principal Registration Service or compliance support. Contact us at 818.657.0288
Algorithmic Trade Regulation FAQs
(click on list item for answer)
What is required to qualify as a Securities Trader or Securities Trader Principal (Series 57 & Series 24)
To register with FINRA as a Securities Trader the person must pass the Series 57 Securities Trader examination. Four major job functions are performed by Securities Traders: (1) Market Overview and Products – 22 questions; (2) Engaging in Professional Conduct and Adhering to Regulatory Requirements – 21 questions; (3) Trading Activities – 79 questions; and (4) Maintaining Books and Records and Trade Reporting – 12 questions.
The Securities Trader Principal designation is a new principal category put forth for persons supervising applicable HFT and Algorithm Trade activities. There is a grandfathering provision for those who have passed the Series 55 and Series 24 prior to the effective date of January 2016. The Securities Trader Principal designation replaces the Proprietary Trader Principal category. Securities Trader Principals have supervisory responsibility over activities in Rule 2020(c). To qualify as a Securities Trader Principal the candidate must pass Series 57 and Series 24 examinations. Return to top of FAQ list
Algorithmic Trading generally refers to trade systems relying heavily on complex mathematical formulas and high-speed computer programs for determining trading strategy and includes placing orders at a speed and frequency that is impossible for a human trader.
Under the rule, an “algorithmic trading strategy” is an automated system that generates or routes orders (including sending orders for routing and order-related messages, such as cancellations), but does not include an automated system that solely routes orders, in their entirety, to a market center. Covered systems include those that generate or route orders (or order-related messages) in any equity security (including options), preferred security or convertible debt security, whether sent to an exchange or handled over the counter. Examples of systems that are considered algorithmic trading strategies if they generate or route orders and include:
- 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 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 involves 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.
An automated system that solely routes orders received in their entirety to a market center is not considered an “algorithmic trading strategy”. This may include standard order routers that submit retail orders in their entirety to a particular market center for handling and execution. Additionally, an algorithm that generates trading ideas or investment allocations, but is not equipped to automatically generate orders does not generally constitute an algorithmic trade strategy. Return to top of FAQ list
How does FINRA Regulatory Notice 16-21 apply if my firm uses a third party to develop the Algorithm Trade System?
Some firms use algorithmic trading services provided by a third party. In these cases, where design and development of an algorithmic trading strategy is performed solely by a third-party, registration under series 57 is not required with respect to the firm’s activities relating to the design or development of such algorithm. However, associated persons who are able to significantly modify the algorithmic trading strategy in-house must be a Securities Trader.
Firms engaging a third-party to build an algorithmic trading strategy for the firm are advised the third-party in the design or development of the algorithmic trading strategy must be a Securities Trader. Further, if the firm directs the third-party significantly as to the algorithmic trading strategy, such direction also must be by a Securities Trader. Finally, after the firm system is launched, the person primarily responsible for any significant modifications must be a Securities Trader. Return to top of FAQ list
In some cases, a person implementing changes to trade strategy may not be required to hold the Series 57 designation. For example, individuals under a lead developers supervision are generally not required to register as series 57 if they are not responsible for design, development, or significant modifications, such as a junior developer.
FINRA generally requires all “registered persons” be assigned to a “registered principal” who has supervisory authority.
This amendment requires associated persons responsible for the design, development, or significant modification; or day-to-day supervision to pass the series 57 examination. In practice developers may not currently report to a registered person. FINRA believes it is acceptable to assign a lead developer to an appropriate registered person and does not required every person associated with the system be registered, and will evaluate each firms supervisory structure on a case-by-case basis. Return to top of FAQ list
FINRA’s goal is to ensure that firms identify and register one or more associated persons who 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). The person must be able to evaluate the trading strategy design and determine that it achieves business objectives and regulatory compliance concerns.
Specifically, beginning January 30, 2017, each associated person who is primarily responsible for the design, development or significant modification of an algorithmic trading strategy (relating to equity, preferred or convertible debt securities), or who is responsible for the day-to-day supervision or direction of such activities, must pass the Series 57 exam and register as a Securities Trader.
For example, a lead developer who liaises with a head trader regarding algorithmic strategy and is responsible for day-to-day supervision or the implementation team must be registered. Individuals under a lead developers’ supervision (junior developers) are not required to register.
Having the Chief Compliance Officer register as a Securities Trader or Securities Trader Principal will help ensure a supervision structure is in place for compliance oversight of the algorithmic trade strategy. Return to top of FAQ list
Who is ultimately responsible for mishaps should the algorithm fail to function or comply with compliance standards?
Generally registered principals who have a requisite degree of authority and responsibility over the conduct of a line employee are liable for the line employee actions. Determination of supervisory status may include;
- Has the person clearly been given, or otherwise assumed, supervisory authority or responsibility for particular business activities or situations?
- Do the firm’s policies and procedures identify the person as responsible for supervising or overseeing business persons or activities?
- Did the person have the power to affect another’s conduct? For example, did the person have the ability to hire, reward or punish that person?
- Did the person otherwise have authority and responsibility such that he or she could have prevented the violation from continuing, even if he or she did not have the power to fire, demote or reduce the pay of the person in question?
- Did the person know that he or she was responsible for the actions of another, and that he or she could have taken effective action to fulfill that responsibility?
- Should the person nonetheless reasonably have known in light of all the facts and circumstances that he or she had the authority or responsibility within the administrative structure to exercise control to prevent the underlying violation?
Firms themselves and the registered principals are assigned responsibility for the actions of supervised employees regardless of whether they are an internal line employee or an outsourced service, or other third party relationship. Return to top of FAQ list
Yes, FINRA released guidelines for firms engaged in Algorithmic Trade Strategy in March 2016, Regulatory Notice 15-09. Their Supervision and Control practices guide is for firms engaging in Algorithmic Trading Strategy and covers the areas of General Risk Assessment and Response; Software / Code Development and Implementation; Software Testing and System Validation; Trading Systems; and Compliance. The suggested practices were compiled by FINRA staff in response to examination and investigation results of industry algorithmic trade firms. Return to top of FAQ list