Buy Side Shoulders Compliance Burden

Terry Flanagan

While regulators take up the task of making the markets safer, individual buy side traders are accepting the lion’s share of responsibility for seeing that their trades are executed as effectively as possible.

“Dark pools and algorithmic trading are developed primarily from the sell side, but the responsibility for using them lies with the buy side trader,” said Craig Jensen, principal and head trader at Armstrong Shaw Associates. “We need to understand what a particular broker’s policies are with regard to anti- gaming and order routing. You can’t just add something and say that it works.”

The Securities and Exchange Commission’s proposed Regulation SCI (Systems Compliance and Integrity) puts the onus on market participants to have comprehensive policies and procedures in place surrounding their technological systems.

The new requirement will present challenges for compliance professional, especially the Chief Compliance Officer, who is responsible for the creation and enforcement of reasonable supervisory procedures related to the implementation and maintenance of applicable technology and the software that operates it.

For the past two decades, self-regulatory organizations have followed a voluntary set of principles articulated in the SEC’s Automation Review Policy and participated in what is known as the ARP Inspection Program.

The SEC, in its proposed Regulation SCI, has requested comment on whether entities other than self -regulatory organizations, alternative trading systems, plan processors or exempt clearing agencies subject to the Commission’s Automation Review Policy should be included in the definition of a SCI entity.

The Securities Transfer Association, an industry group, does not believe that the inclusion of transfer agents in the definition of SCI entities is warranted. Transfer agents’ primary functions are the maintenance of the registers of ownership of issuers’ securities and the timely registration of transfers of ownership on those registers.

In today’s marketplace, trading, clearance, and settlement activities are carried out within the internal records of market constituents such as The Depository Trust Company (“DTC”) and its participants.

“They do not have systems that directly support trading, clearance and settlement, order routing, market data, regulation, or surveillance, the critical functions that the Commission is trying to protect,” said STA president Charles Rossi in a comment letter. “The current ARP does not include transfer agents, and there is no valid reason to include them in the Regulation that will supersede it.”

The SEC has noted that the continuing evolution of the securities markets to where they have become almost entirely electronic and highly dependent on sophisticated trading and other technology (including complex regulatory and surveillance has posed challenges for the ARP Inspection Program.

“One of the challenges today is that so many people have access to the market in real time, but lack the understanding of what the product or specific algo within that product does,” said Jensen. “Some think they can just plug it in and sit back, but that’s not best execution.”

Reg SCI is designed to ensure that core technology of national securities exchanges, alternative trading systems, clearing agencies, and plan processors meet certain standards, that these entities conduct business continuity testing with their members and participates, and provide certain notification regarding systems disruptions and other types of systems issues.

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