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Regulation and Compliance > Federal Regulation > FINRA

E-Trade to Pay $350K Over Weak Trading Oversight

By Jeff Berman

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What You Need to Know

  • E-Trade didn't have a supervisory system in place to detect potentially manipulative trading by clients, FINRA alleged.
  • Surveillance of wash trades was insuff
  • The Morgan Stanley subsidiary declined to comment on FINRA's allegations and sanctions.

The Financial Industry Regulatory Authority has ordered E-Trade to pay $350,000, alleging that from February 2016 through November 2021, it “failed to establish and maintain” a supervisory system for detecting “potentially manipulative trading” by its clients.

E-Trade should have had written procedures in place that were “reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules,” according to the broker-dealer self-regulator. Of the $350,000, $144,500 is payable to FINRA.

E-Trade’s actions violated FINRA Rules 3110 (regarding supervisory systems) and 2010 (governing standards of commercial honor and principles of trade), according to FINRA.

Without admitting or denying FINRA’s findings, E-Trade signed a letter of acceptance, waiver and consent on Dec. 31, consenting to the sanctions. FINRA signed the letter on Monday.

E-Trade on Wednesday declined to comment on FINRA’s allegations and the sanctions imposed on it, which also included a censure and an agreement to, within 180 days of the notice of acceptance of the AWC, provide FINRA with information showing it implemented a supervisory system.

Morgan Stanley acquired E-Trade for $13 billion in 2020.

E-Trade’s Failures

From December 2016 through November 2021, E-Trade used surveillance reports to identify potential wash trades and prearranged trades by its clients, according FINRA.

“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),” FINRA alleged.

For example, E-Trade used a surveillance report to identify potential wash sales, which it defined as “one or more transactions where there is no change in beneficial ownership,” according to FINRA.

That surveillance system, however, “flagged trades that met this definition only if the total principal value of the trade was more than $1,000, regardless of the price of the underlying security,” FINRA alleged.

E-Trade’s surveillance reports also “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,” according to FINRA.

In addition, E-Trade didn’t have surveillance “reasonably designed to detect trading that artificially increased or decreased the price of thinly traded stocks,” FINRA alleged.

That would include when a client 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,” according to FINRA.

The firm also used surveillance reports to “detect potential intraday manipulative trading [but] the parameter settings of these reports were not reasonably designed to detect” potentially manipulative trading,” FINRA alleged.

For example, the reports flagged only 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, according to FINRA.

But that 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,” FINRA noted.

E-Trade’s surveillance reports also “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,” according to FINRA.

(Photographer: Andrew Harrer/Bloomberg)

Jeff Berman

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