E*TRADE Securities LLC has agreed to a censure and a fine of $350,000 as a part of settlement with the Financial Industry Regulatory Authority (FINRA).
From February 2016 through November 2021, E*TRADE failed to establish and maintain a supervisory system, including written procedures, reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules, related to detecting potentially manipulative trading by its customers.
During the period December 2016 through November 2021, E*TRADE used multiple surveillance reports to identify potential wash trades and prearranged trades by its customers. Certain of these reports, however, used parameters that significantly restricted their ability to detect such trading, particularly in lower priced and thinly traded securities (which may be more easily affected by manipulative trading).
Also, the firm’s surveillance reports would not detect either a potential wash sale or prearranged trade if the two sides of the transaction were executed more than one second apart, even though wash trades and manipulative prearranged trades could be executed more than one second apart.
Further, during the relevant period, E*TRADE used several surveillance reports to detect potential marking-the-close activity by its customers. Starting in February 2017, however, the firm modified the surveillance parameters in these reports in a way that rendered them too restrictive to reasonably detect potential marking-the-close activity, especially in lower priced securities.
In addition, during the relevant period, E*TRADE’s surveillance system was not reasonably designed to detect certain types of potentially manipulative trading.
Specifically, E*TRADE did not have surveillance reasonably designed to detect trading that artificially increased or decreased the price of thinly traded stocks, such as when a customer attempted to artificially influence the price of a security by effecting a series of buy transactions within a short period of time to create the false appearance of trading interest and activity in the security, followed shortly thereafter by transactions on the opposite side of the market to reap profits from an artificially increased price.
Moreover, while E*TRADE used surveillance reports to detect potential intraday manipulative trading, the parameter settings of these reports were not reasonably designed to detect the aforementioned activity. For example, the reports would only flag a pattern of trading for review if the trades executed on both sides of the market were executed within a one- second window and only if the accounts involved held at least ten percent of the shares outstanding at E*TRADE in that security at the end of the trading day.
However, this type of potentially manipulative trading activity could occur over several minutes and in accounts that had reduced their positions below the ten percent threshold during the day.
Additionally, E*TRADE’s surveillance reports only flagged such a trading pattern as potentially manipulative if the pattern included cancelled orders, even though customers can manipulate the price of a security without cancelling orders.
As a result of the foregoing, E*TRADE failed to establish and maintain a supervisory system that was reasonably designed to achieve compliance with applicable federal securities laws and regulations and FINRA rules relating to potentially manipulative trading, in violation of FINRA Rules 3110 and 2010.
FINRA accepted E*TRADE’s settlement offer on January 10, 2022.