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Finra to Take Over Surveillance of NYSE Euronext U.S. Exchanges

The Financial Industry Regulatory Authority will take over surveillance of NYSE Euronext’s U.S. exchanges and responsibility for policing trading violations as part of a further consolidation of market oversight.

The industry-funded brokerage regulator will monitor the stock and equity derivatives markets at the New York Stock Exchange, NYSE Arca and NYSE Amex, Washington-based Finra and NYSE Euronext said in a news release today. The accord must be approved by the Securities and Exchange Commission.

“You need a full view of the world,” said Richard Ketchum, chief executive officer of Finra, “when you’re worried about manipulation, insider trading, a variety of abusive activities.” Someone trying to manipulate markets can submit orders and trade in multiple venues since “the equity markets are very fragmented,” while oversight is currently limited to individual exchanges, he said in an interview.

Increasing automation and competition have reduced the Big Board and Nasdaq’s volume in securities they list from as much as 80 percent in the last decade. Now, two-thirds of trading in their companies takes place off their networks because orders are dispersed across dozens of competing venues. The move by Finra and NYSE is an attempt to bring oversight of a large segment of that into one organization.

Finra is currently focused on equities oversight. Options “would follow after that,” said Steve Luparello, vice chairman of Finra. The goal is for surveillance to be consolidated first within each asset class, and then across equities and options, to provide a “true picture of the marketplace,” he said.

Surveillance Across Markets

SEC Chairman Mary Schapiro said in February that the commission plans to conduct surveillance across markets -- and create a consolidated audit trail, a system to track all order and trade information. James Brigagliano, deputy director of the SEC’s division of trading and markets, told Bloomberg News on April 30 creating that is a “front-burner issue.” The SEC may ask markets to submit a plan for the audit trail, which would allow regulators to track order and trade information, Brigagliano said.

“This agreement will strengthen market regulation by consolidating surveillance and enforcement responsibilities across multiple markets,” NYSE Euronext Chief Operating Officer Lawrence Leibowitz said in a statement. “Today, trading is dispersed among numerous venues and no single regulator has responsibility for monitoring data and pursuing activity.”

Employee Transfer

The agreement between Finra and NYSE Euronext involves about 225 employees, the “significant majority” of whom will be transferred to Finra in June, according to Ketchum. The consolidation is expected to be complete before July, Finra and NYSE Euronext said, at which point Finra will oversee 75 percent to 80 percent of U.S. equity markets by volume. NYSE Euronext will pay Finra to oversee its exchanges.

Conducting oversight across at least 75 percent of the market “is way better than 20 or 50 percent, but it’s not 100 percent,” Ketchum said. Finra is seeking to expand the number of markets it monitors. “We’re the logical entity to do consolidated surveillance,” Ketchum said.

Finra plans to move the firms it oversees to a single audit trail for equity securities, Ketchum said. The program in place for Nasdaq-listed securities, called the Order Audit Trail System, is the “logical” choice for a single unified system for all stocks, he said. Firms that currently use the NYSE Order Tracking System for stocks listed on that exchange would have to adopt the one used for Nasdaq. Efforts have been under way for at least a year to combine the two systems.

Improving Oversight

Finra also wants non-member brokers to join and improve its oversight over more market participants, Ketchum said. Finra plans to examine the trading activity fee it imposes on brokers, which has deterred some firms from joining. All brokers must be registered with the SEC and a self-regulatory organization such as an exchange, while those dealing with customers must be Finra members as well.

“It’s better for active participants in the market to be Finra members,” Ketchum said. The TAF fee has a “disproportionate impact” on proprietary trading firms and Finra is “going to take a hard look at that,” he said.

In addition to exchanges, Finra operates two facilities that report transactions occurring away from public markets. One is run in conjunction with Nasdaq and the other with NYSE. Brokers including market makers and dark pools, which trade stocks without displaying quote information publicly, report their transactions off exchanges to these entities, giving Finra information about that activity.

History on Consolidation

NYSE and Finra began discussing consolidating their surveillance business in 2007 when Ketchum was CEO of NYSE Regulation, the oversight arm at the exchange operator, and Finra was still known as NASD. Discussion about how to implement an arrangement began “earlier in 2009,” he said. Ketchum joined Finra in March 2009 after then-CEO Mary Schapiro became chairman of the SEC.

Finra was created through the 2007 combination of the NASD and most of the New York Stock Exchange’s regulatory unit. Since the merger, Finra has had responsibility for policing trading on Nasdaq and other markets, overseeing rules for broker-dealers and ensuring that member firms sell clients suitable investments. NYSE and other exchanges will maintain regulatory staff to oversee member firms and trading on their venues.

“Each marketplace has its own requirements and some surveillance is always local,” Ketchum said.

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