FINRA fines Instinet for violations of Regulation NMS
Instinet, LLC has agreed to pay a fine as a part of a settlement with the Financial Industry Regulatory Authority (FINRA).
During the period from August 1, 2019, through September 28, 2020, Instinet violated Rule 611(c) of Regulation National Market System (NMS) of the Securities Exchange Act of 1934 (Exchange Act) by failing to take reasonable steps to establish that the intermarket sweep orders (ISOs) it routed to certain market centers met the requirements set forth in Exchange Act Rule 600(b)(31).
Specifically, between November 26 and December 2, 2019, an error in Instinet’s coding logic in its backup data center resulted in its Smart Order Router (SOR) failing to capture current quotation data from a direct data feed when taking snapshots for making routing decisions.
Multiple times throughout that period, Instinet automatically switched to its backup datacenter when the primary data center did not capture up-to-date quotations from a direct market data feed due to coding errors. The firm directed its SOR to consume market data from the backup datacenter. After switching to the backup datacenter, however, the Firm’s trade through monitor began reporting potential trade- throughs and the firm then directed the SOR to switch to the Securities Information Processor (SIP) feed.
As a result of the failure to capture up-to-date quotations, Instinet routed orders that potentially traded through protected quotations. A programming error in the code released to the backup datacenter on November 22, 2019, caused the potential trade-throughs. The firm corrected this issue by implementing updated code on December 2, 2019, which was effective on December 3, 2019.
Additionally, on multiple dates in 2020, Instinet experienced connectivity problems with direct market data feeds, resulting in its SOR failing to capture quotation data from multiple exchanges when taking the snapshots it used for ISO-routing decisions. For example, when the firm received more data than its server could process, its SOR disconnected from the direct market data feeds. Compounding the server capacity issue, on one relevant occasion, Instinet’s trade through monitor experienced an issue comparing a direct market data feed to the SIP, and as a result, the firm failed to detect the disconnect.
In other instances, the trade through monitor logged repeated unsuccessful reconnection attempts that were eventually escalated for manual reconnection. In all relevant instances, while Instinet took corrective action by switching to the SIP feed the same day, Instinet routed orders that potentially traded through protected quotations.
Regarding the connectivity issues, FINRA began its investigation in or around August 2020 on behalf of FINRA and multiple exchanges. The firm took steps to address the connectivity issues by increasing its server capacity in September 2020 and, again, in May 2021. The firm also developed and implemented enhanced surveillance to detect and respond to connectivity issues in November 2020.
Also between August 1, 2019, and September 28, 2020, Instinet’s system logic would treat a quote as “stale” if it did not receive an ISO execution at a protected venue and would continue to treat the quote as stale until it received a quote update from that destination. As a result, Instinet’s SOR would not re-route to any destination after a quote was marked stale and there was no quote update received from that destination. There was no limit to how long the firm would wait to re-route to the original exchange. At times, Instinet waited more than one second before re-routing after a quote was marked stale.
In at least one instance, INCA traded through a protected quotation it marked stale approximately three seconds after it did not receive an execution at that protected venue.
Instinet, therefore, did not take reasonable steps to establish that ISOs it routed met the requirements of Exchange Act Rule 600(b)(31) in violation of Exchange Act 611(c). The firm revised its system logic to address this issue on or about October 5, 2020.
Therefore, Instinet violated Rule 611(c) and FINRA Rule 2010.
Between August 1, 2019, and September 28, 2020, Instinet’s supervisory system, including its WSPs, was not reasonably designed to achieve compliance with Exchange Act Rule 611(c).
Instinet’s supervisory system was unreasonable because it did not detect potential trade throughs caused by the fact that it waited more than one second before re-routing to a trading center’s protected quotation after receiving a partial-fill or no-fill response to an order seeking to execute against the trading center’s quotation at the same price.
Additionally, Instinet’s WSPs failed to establish processes to achieve compliance with Exchange Act Rule 611(c) during this time period. For example, even though Instinet relies on its trade through monitor to monitor for and respond to disconnections, its WSPs do not contain any information about this process.
Instinet also ignored red flags in its supervisory system that should have alerted the firm of the need to address its connectivity issues to ensure that the ISOs it routed complied with Exchange Act Rule 611(c). Despite experiencing data connectivity issues over multiple dates, the firm did not completely remediate the issues until after regulatory inquiries.
Thus, during the period of August 1, 2019, and September 28, 2020, Instinet’s supervisory system, including its WSPs, was not reasonably designed to achieve compliance with Exchange Act Rule 611(c).
Therefore, Instinet violated FINRA Rules 3110 and 2010.
Instinet has agreed to the imposition of the following sanctions:
- a censure and
- a total fine of $450,000, of which $175,099.36 shall be paid to FINRA. The balance of the sanction will be paid to BYX, BZX, EDGA, EDGX, NYSE, NYSE Arca, Investors Exchange, LLC, NYSE American LLC, NYSE National, Inc., and NYSE Chicago, Inc.