On April 7, 2016, the SEC approved a proposal by the Financial Industry Regulatory Authority (FINRA) to amend NASD Rule 1032 (Categories of Representative Registration). The amendments will expand the requirements of NASD Rule 1032 to require associated persons of broker-dealers to register with FINRA as a securities trader if they are either:

Currently, an associated person must register as a securities trader only if, with respect to transactions in equity, preferred or convertible debt securities effected otherwise than on a securities exchange, that person is engaged in proprietary trading, the execution of transactions on an agency basis, or the direct supervision of those activities.

Under the amended rule, algorithmic trading strategy will mean an automated system that generates or routes orders or order-related messages, such as routes or cancellations. This definition will not include an automated system that solely routes orders received in their entirety to a market center.

The expanded registration requirement will apply to orders and order-related messages whether ultimately routed or sent to be routed to an exchange or over the counter. An order router will not be considered an algorithmic trading strategy unless it performs additional functions that would be considered an algorithmic trading strategy.

An algorithm that solely generates trading ideas or investment allocations (including an automated investment service that constructs portfolio recommendations) but that is not equipped to automatically generate orders and order-related messages to effectuate those trading ideas into the market (whether independently or via a linked router) will not be considered an algorithmic trading strategy.

Associated persons covered by the expanded registration requirements will be:

The aim of the proposal is to ensure the registration of one or more associated persons who possess knowledge of, and responsibility for, both the design of the intended trading strategy and the technological implementation of the strategy, sufficient to evaluate whether the resulting product is designed to achieve regulatory compliance in addition to business objectives. For example:

FINRA Rule 3110(a)(2) currently requires that all registered persons be designated to an appropriately registered principal or principals with authority to carry out the supervisory responsibilities of the broker-dealer for each type of business in which it engages for which registration as a broker-dealer is required. As a result of amended NASD Rule 1032, broker-dealers will be required to designate developers to a registered principal for purposes of Rule 3110(a)(2). Broker-dealers may "assign" a lead algorithm developer (or other non-trader) engaging in covered activities to one or more other registered persons of the broker-dealer that supervise trading activities outside the developer's or other non-trader's usual reporting line. Accordingly, the new amendments may not necessarily trigger registration requirements for the current supervisor of algorithm design or development personnel if that supervisor is not responsible for the day-to-day supervision or direction of the specific activities covered by the amendments. However, the firm must designate an appropriately registered person to be responsible for supervising the algorithmic trading strategy activities.

The release notes that a broker-dealer employing an algorithm is responsible for the algorithm's activities whether the algorithm is designed or developed in-house or by a third-party. Therefore, robust supervisory procedures, both before and after deployment of an algorithmic trading strategy, are a key component in protecting against problematic behavior stemming from algorithmic trading.

Associated persons responsible for monitoring or reviewing the performance of an algorithmic trading strategy will be required to register under NASD Rule 1032(f). Even where a firm purchases an algorithm off-the-shelf and does not significantly modify the algorithm, the associated person responsible for monitoring or reviewing the performance of the algorithm will be required to register under NASD Rule 1032(f).

FINRA will announce the effective date of amended NASD Rule 1032(f) in a regulatory notice to be published no later than 60 days following the SEC's approval. The effective date of the amendments will be no sooner than 180 days following publication of the regulatory notice but no later than 300 days following the SEC's approval.

To learn more about the rules governing FINRA's supervision of broker-dealers, see Practice Note, FINRA Supervision Rules.