SFC Reprimands And Fines Instinet Pacific Limited $17.3 Million For Failures Concerning Its Electronic And Algorithmic Trading Systems And Alternative Liquidity Pool

The Securities and Futures Commission (SFC) has reprimanded and fined Instinet Pacific Limited (IPL) $17.3 million after resolving concerns over IPL’s breaches of the Code of Conduct in relation to its electronic and algorithmic trading systems and alternative liquidity pool (ALP)(Notes 1 & 2).

In November 2016, the SFC and IPL jointly engaged independent reviewers to review IPL’s electronic and algorithmic trading systems and ALP.  The review findings revealed that IPL failed to ensure:

• reasonable controls were in place to prevent its algorithmic trading system from generating and passing erroneous and disorderly orders to the market on three occasions between December 2014 and January 2016 (Note 3);
• non-proprietary orders received execution priority over proprietary orders in its ALP before May 2016 (Note 4);
• compliance with documentary requirements of the Code of Conduct, including:
  • the incident reports concerning its electronic trading system did not contain the minimum details as required (Note 5);
  • the access log for its ALP was not adequately maintained (Note 6);
  • the guidelines for its ALP was not sufficiently comprehensive, accurate and up-to-date (Note 7); and
  • the documentation on the design, development, risk management controls, order cancellation function, pre-trade risk controls as well as smart order router controls of its electronic and algorithmic trading systems and ALP was not sufficiently comprehensive (Note 8).

In reaching the resolution, the SFC took into account all relevant circumstances, including that IPL:

• involved their senior management in the liaison with the SFC about the regulatory concerns;
• took the initiative to bring this matter to a conclusion by cooperating with the SFC to address the regulatory concerns in the disciplinary action; and
• engaged independent reviewers to conduct a review of the SFC’s regulatory concerns and identify the deficiencies in its internal controls.

The SFC also took into consideration an undertaking by IPL’s board of directors that reasonable steps will be implemented to ensure the failures set out above will be rectified within 12 months; otherwise, similar failures would have resulted in a substantially higher level of fine.

End

Notes:

1. IPL is licensed under the Securities and Futures Ordinance to carry on business in Type 1 (dealing in securities), Type 4 (advising on securities) and Type 7 (providing automated trading services) regulated activities.
2. Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct).
3. General Principle 2 of the Code of Conduct provides that a licensed corporation should exercise due skill, care and diligence in carrying on its business in regulated activities in the interests of market integrity.  Paragraph 3.3.1 of Schedule 7 to the Code of Conduct provides that a licensed corporation should have controls that are reasonably designed to monitor and prevent the generation of or passing to the market for execution order instructions from its algorithmic trading system which may be erroneous or may interfere with the operation of a fair and orderly market.
4. Paragraph 19.6 of the Code of Conduct provides that irrespective of the time when orders are placed, a licensed corporation operating an ALP should ensure that orders of users which are not proprietary orders have priority over proprietary orders when such orders are being transacted at the same price.
5. Paragraph 1.3.1(d) of Schedule 7 to the Code of Conduct provides that a licensed corporation should keep incident reports for all material system delays or failures of its electronic trading systems.  Annex to Schedule 7 sets out the minimum details that should be included in the incident reports.
6. Among others, paragraph 16(b) of Schedule 8 to the Code of Conduct provides that an ALP operator should maintain an adequate access log that records any approval given for staff members’ access to its ALP and the basis upon which such access was permitted in each case.
7. Among others, paragraph 19.7(a) of the Code of Conduct provides that a licensed corporation should, by means of ALP Guidelines (as defined in paragraph 19.2(a) of the Code of Conduct), provide sufficiently comprehensive information to the ALP users to ensure that they are fully informed as to the manner in which the ALP operates.  Paragraph 9 of Schedule 8 to the Code of Conduct provides that an ALP operator should prepare and publish comprehensive and accurate ALP Guidelines concerning its ALP on its website.  Paragraph 11 of Schedule 8 to the Code of Conduct provides that an ALP operator should revise or update its ALP Guidelines as necessary and publish the same on its website and circulate them to ALP users, identifying and explaining the amendments that have been made.
8. Among others, paragraph 18.6 of and paragraphs 1.3 and 3.4 of Schedule 7 to the Code of Conduct, and paragraph 19.10 of and paragraph 20 of Schedule 8 to the Code of Conduct provide that a licensed person should keep, or cause to be kept comprehensive documentation of the design, development, deployment and operation of, and the risk management controls for its electronic and algorithmic trading systems and ALP.