As Regulators Boost Market Surveillance Capabilities, Firms Should Enhance Self-Monitoring to Reduce Trading Violations

Douglas WilbertDouglas Wilbert, Managing Director Risk and Compliance

Regulatory fines in any industry are not new. For as long as there have been regulations, hefty fines have served as the clearest and most concise method for regulators to publicly rebuke corporate offenders and wrongdoers.

Over the last decade, the financial services industry has seen multiple billion-dollar fines, and they have been so recurrent that the public and media are almost desensitized to fines that don’t start with a “B.” However, every so often, it is not just the size of the fine that grabs attention, but the textual context related to the fine.

This was exactly the case on August 19, 2020, when the Commodity Futures Trading Commission (CFTC) ordered an institution to pay a total of $127.4 million in civil monetary penalties, including $77.4 million specifically for spoofing, an illegal form of market manipulation in which a trader places a large order to buy or sell a financial asset, such as a stock, bond or futures contract, with no intention of executing. According to the regulator, the latest order marks the single largest civil monetary penalty ever ordered in a spoofing case. The previous record for the largest total monetary relief ordered in a spoofing case was a $67.4 million fine levied against a proprietary trading firm in November 2019.

Notably, the CFTC’s latest announcement included the following quote from Chairman Heath P. Tarbert:

“These record-setting penalties reflect not only our commitment to being tough on those who break the rules, but also the tremendous strides the agency has made in data analytics. Our ability to go through the electronic order book and look across markets has enabled the CFTC to not only spot misconduct, but also to uncover false and misleading statements…Over the last year, we have ushered in a new era of enforcement at the CFTC. Wrongdoers now have increasingly fewer ways to conceal their misconduct and face an even more unified front from civil and criminal authorities.”

Tarbert’s bold statements about the CFTC’s trade surveillance suggest the regulator is so confident in its enhanced capabilities that it is daring traders to test its regulatory mettle. While the specifics of the regulator’s upgraded surveillance capabilities are unknown and we cannot fully validate the efficacy of Tarbert’s statements, the CFTC has publicly disclosed that it receives transactional data roughly a day after execution, with order-level details that include trader identification. Also, it is clear the regulator is not only looking at spoofing but at other areas of market abuse, including wash trading and artificial price manipulation.

The CFTC’s quick data aggregation approach may not seem like a bold change in operating procedure, but it is a dramatic development for the regulator. The approach provides a centralized, cohesive strategy to effectively find market abuse and reduce the time required to review and prosecute violators of market conduct. The capacity to speed up investigations and prosecutions is a welcome change for the regulator, which has a history of being bogged down by time-consuming cases, such as the May 2010 flash crash investigation, which took five years and the aid of whistleblowers to conclude. Now, given its global view of trade executions and access to readily available data, linking identifying characteristics (e.g., executing party, time of execution, security and price) across exchanges can occur seamlessly, and the CFTC, which does not have a dual demand to regulate itself, can focus more on a wide range of market infractions.

Rooting out market abuse has always been important to financial firms; however, for many firms, trade surveillance is not their strongest suit. In today’s hyper trading environment of multiple execution points, expanded trading and advanced algorithms, it has never been more important for firms to monitor execution carefully. Firms that are unsure of their ability to quickly find and identify market abuse transactions should consider the following recommendations:

  • Conduct a gap analysis of trade surveillance policies, procedures and technology
  • Enhance processes in accordance with any deficiencies or gaps found as a result of previous audits
  • Revisit and self-identify previous concerns raised by regulators
  • Create a go-forward strategy to address increased sophistication of algorithms and expansion of securities (e.g., crypto assets)
  • Validate market abuse models regularly to assure they are fit for purpose

These recommendations are just a few that firms should consider to proactively manage market abuses in this heightened regulatory environment. Visit our website to learn more about other effective ways of measuring and mitigating regulatory risks.

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