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Wall Street watchdog FINRA to monitor BATS' markets

By John McCrank

Feb 6 (Reuters) - Exchange operator BATS Global Markets said on Thursday it would outsource part of the surveillance of its four U.S. stock markets to the Financial Industry Regulatory Authority, expanding the industry-funded watchdog's oversight to nearly all equities markets.

FINRA has similar agreements with most other U.S. exchanges, where it mines the exchange data to detect abusive market practices, conducts investigations into those practices, and prosecutes cases that warrant formal disciplinary action.

Adding BATS' data to the mix will allow FINRA to see 99 percent of the activity on U.S. stock exchanges.

"It's important because we are seeing that people are trying to spread their activity across multiple markets to try to avoid detection," said Tom Gira, head of market regulation at FINRA.

FINRA mines the data to detect market manipulation, such as "spoofing" and "layering," where market participants use algorithms to place buy or sell orders that are never executed, in order to move prices through the false impression of demand.

Prior to Monday, FINRA had just an 80 percent view of the market, but that rose to 90 percent with the addition of data from Direct Edge, which recently closed its merger with BATS to create the No. 2 U.S. stock market operator behind IntercontinentalExchange Group's NYSE Euronext unit. Data from the two legacy BATS exchanges is expected to be included by early 2015.

BATS has traditionally done its own surveillance, making referrals to the Chicago Board Options Exchange for further investigation. CBOE had no comment on Thursday.


Exchanges began as member-owned trading platforms, but have evolved over the years into for-profit businesses, competing with their broker-dealer customers for much of the same order flow, with around 40 percent of equities trades taking place on private non-exchange venues.

As self-regulatory organizations (SROs), exchanges are responsible for setting and enforcing rules that govern their members' activities, as well as making sure they comply with federal securities laws.

Critics in the financial services industry have argued that exchanges should be stripped of their self-regulatory status, because it creates conflicts of interest, and because much of their self-regulatory function is outsourced.

"With more and more activity going to FINRA in the market regulation space, it doesn't make sense for exchanges to continue to be SROs," said TR Lazo, associate general counsel for Wall Street trade group, the Securities Industry and Financial Markets Association (SIMFA).

"It would make sense to have, in this case, FINRA just be the SRO, rather than have exchanges hire FINRA to do it and then them retain the authority," said Lazo, a former general counsel of NYSE Regulation.

Exchanges do monitor their own data in real-time, and make recommendations to FINRA when they spot potential problems. They also have regulatory duties when conducting initial public offerings.

Late last month, FINRA was granted approval by the U.S. Securities and Exchange Commission to begin monitoring stock transactions on off-exchange trading venues, in a bid to increase the transparency of the markets.