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Regulatory watchdog FINRA to oversee Direct Edge's surveillance
May 22, 2013 / 7:07 PM / 4 years ago

Regulatory watchdog FINRA to oversee Direct Edge's surveillance

NEW YORK (Reuters) - U.S. exchange operator Direct Edge has agreed to allow the Financial Industry Regulatory Authority to oversee surveillance of its two stock exchanges, expanding the watchdog regulator’s oversight to more than 90 percent of U.S. equity markets.

Direct Edge expects the agreement to become operative in the fourth quarter, when all of the exchange operator’s third-party regulatory services will be consolidated with FINRA, the two firms said in a statement on Wednesday.

FINRA already performs examination and disciplinary services on behalf of Direct Edge, which vies with BATS Global Markets as the third-largest U.S. exchange operator.

BATS does its own surveillance and then makes referrals to the Chicago Board Options Exchange for further investigation, a BATS spokesman said.

The expansion of FINRA’s surveillance services for U.S. exchange operators, including NYSE Euronext and Nasdaq OMX, comes as their status as self-regulatory organizations has come under scrutiny.

SROs are not just exchanges. FINRA and other organizations, including the National Securities Clearing Corp and the Depository Trust Co, are SROs.

Critics in the financial services industry have questioned whether exchanges should retain SRO status while outsourcing the bulk of their regulatory functions to FINRA.

Brokers Knight Capital Group, Citadel Securities and Goldman Sachs own almost 20 percent of Direct Edge, leading to concerns about potential conflicts of interest.

Thomas McManus, chief compliance and regulatory officer at Direct Edge, acknowledged last week that while FINRA does the “heavy lifting,” conducting exams and providing recommendations, “we make the ultimate decision.”

Even with FINRA overseeing surveillance, the exchanges retain responsibility and still conduct their own work, McManus said.

“It’s not just a ‘check-the-box’ exercise,” he said at a Securities Industry and Financial Markets Association conference.

Commissioner Luis Aguilar of the Securities and Exchange Commission said two weeks ago that the SEC needs to review how it supervises financial markets. Conflicts of interests between SROs and their members, which include brokers with ownership stakes, may lead these organizations to be “less inclined to enforce rules vigorously,” he said.

In October 2011, the SEC sanctioned units of Direct Edge amid allegations its weak internal controls led to millions of dollars in trading losses and a systems outage.

No fine was levied, but Direct Edge was required to correct the problems and take remedial measures.

Reporting by Herbert Lash, additional reporting by Sarah N. Lynch in Washington; Editing by Maureen Bavdek and Dan Grebler

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