FINRA Highlights Manipulative Trading Risks and Supervision Expectations

By Jonathan Hall, Esq.

Manipulative trading remains a key enforcement focus for FINRA and other regulators. In recent guidance, FINRA emphasized that firms must maintain supervisory systems reasonably designed to detect and prevent impermissible trading practices, including schemes that artificially inflate or suppress security prices, create misleading trading activity, or misuse material non-public information. 

For broker-dealers, these risks are not limited to blatant “pump-and-dump” schemes. FINRA has made clear that firms are expected to maintain reasonably designed surveillance, escalation, and investigative procedures that account for the firm’s business model, sources or order flow, and product mix. 

Regulatory Framework: FINRA Rules Prohibiting Manipulative Trading

FINRA rules prohibit a wide range of impermissible trading practices, including manipulative, deceptive, and fraudulent devices. These include FINRA Rule 2010, Rule 2020, and several trading practice rules such as Rule 5210, Rule 5270,  Rule 5290, and Rule 6140. 

In addition, FINRA Rule 3110 requires firms to include in their written supervisory procedures a process to review securities transactions that is reasonably designed to identity trades that may violate the Securities Exchange Act and FINRA rules prohibiting manipulative and deceptive trading activity. 

FINRA Findings: Common Compliance Weaknesses 

FINRA has identified recurring deficiencies in firm supervisory programs, particularly where firms fail to implement written supervisory procedures and surveillance systems reasonably designed to detect manipulative trading. 

Inadequate Written Supervisory Procedures (WSPs)

FINRA has observed that some firms lack procedures reasonably designed to identify patterns of manipulative conduct based on the types of businesses the firm engages in. Common issues include failing to identify who is responsible for monitoring, failing to outline escalation steps, and failing to tailor procedures to different sources or order flow, including proprietary trading, retail customers, institutional customers, and foreign financial institutions. 

Surveillance Deficiencies

FINRA has further observed that some firms do not establish surveillance systems reasonably designed to detect common manipulative schemes such as spoofing, layering, wash trades, marking the close, odd-lot manipulation, or prearranged trades. 

FINRA has emphasized the importance of documenting surveillance parameters, setting meaningful thresholds, reviewing alerts in a timely manner, dedicating adequate resources to alert reviews, and periodically evaluating surveillance effectiveness as the firm’s business changes.

Increase in Small-Cap Fraud and Pump-and-Dump Schemes

FINRA has reported a continued increase in suspected pump-and-dump schemes involving small-cap, exchange-listed issuers, including schemes connected to IPOs and post-IPO trading activity. FINRA has discussed these risks in the FINRA Annual Regulatory Oversight Report and in Regulatory Notice 22-25. 

Effective Practices Firms Should Consider

FINRA has emphasized that firms should tailor surveillance and supervisory systems to detect different forms of manipulative trading activity based on product class, trading venue, and customer profile. 

Effective practices may include monitoring for red flags associated with customer accounts that have relationships with issuers, reviewing money movements between issuers and customer accounts, monitoring activity across multiple trading platforms, and supervising for efforts to artificially support or suppress security prices.

FINRA has also highlighted the importance of maintaining robust information barriers to prevent the misuse of material non-public information, including controls designed to prevent front running and trading ahead in connection with block transactions and exchange-related products. 

Conclusions 

FINRA’s recent guidance reflects continued regulatory focus on manipulative trading schemes and firm obligations to maintain reasonably designed supervision and surveillance programs. Firms should evaluate whether their written supervisory procedures, surveillance controls, escalation processes, and internal investigation procedures are appropriately tailored to the firm’s business and trading activity.

Firms that fail to address these issues may face heightened regulatory scrutiny, enforcement risk, and reputational harm.

If you have questions about FINRA trading supervision requirements, surveillance controls, or potential regulatory exposure arising from trading activity, please contact a securities attorney at inquiry@galbraithlawfirm.com or 212.203.1249.