FINRA’s rules should be modernized to address economic costs, evolving markets, technology advancements, and regulatory inefficiencies. Below are key areas for modernization, including specific rules, guidance updates, and regulatory overlaps that warrant attention.
1. Focus Areas for Modernizing FINRA Rules
Several FINRA rules are outdated, overly burdensome, or fail to account for modern trading environments and technologies.
A. Short Selling & Market Transparency Rules
Rule 4320 – Short Sales in OTC Equity Securities
This rule should be revised to increase reporting requirements for OTC short positions and provide real-time data transparency to prevent market manipulation (e.g., MMTLP scenario).
Expand close-out requirements under Regulation SHO (Rule 204) to eliminate extended failures to deliver (FTDs).
Rule 4560 – Short Interest Reporting
Require daily reporting (instead of semi-monthly) for more transparency on short interest levels.
Mandate reporting of total synthetic shares created through swaps or derivatives.
B. Market Halt & Trading Suspension Rules
Rule 6440 – Trading and Quotation Halt in OTC Equity Securities
FINRA should reform U3 halt procedures to prevent unjustified suspensions (e.g., MMTLP).
Introduce a formal appeals process so investors can challenge trading halts.
Rule 11892 – Clearly Erroneous Transactions
Update criteria for trade cancellations to prevent market makers from abusing “erroneous” cancellations to avoid fulfilling transactions that move against them.
C. Market Making & Order Handling
Rule 5210 – Marking of Customer Orders
Require brokers to identify and report synthetic share orders created through market maker internalization.
Rule 5320 – Prohibition Against Trading Ahead of Customer Orders
Strengthen enforcement to prevent brokers from routing orders through dark pools before executing retail trades.
FINRA should modernize guidance in several areas where regulatory gaps, risks, and inefficiencies exist.
A. Naked Shorting & Failures to Deliver (FTDs)
FINRA should clarify guidance on how synthetic shorts and FTDs are addressed under Regulation SHO.
Provide more frequent public disclosures of FTD data, including off-exchange (dark pool) failures.
B. Alternative Trading Systems (ATS) & Dark Pools
FINRA should enhance transparency requirements for dark pool order routing, ensuring brokers prioritize best execution for retail orders rather than internalizing trades.
C. Special Purpose Acquisition Companies (SPACs)
Guidance should clarify how retail investors in SPACs are protected from dilution, insider trading, and hidden fees.
Establish rules on custody and liquidity requirements for digital assets.
3. FINRA Rules That Should Be Modernized to Support Innovation
To encourage innovation and modern technology, FINRA should focus on removing unnecessary barriers while ensuring investor protection.
A. Streamlining Broker-Dealer Registration for Fintech Startups
Rule 1014 – Membership Application Process
Simplify the registration process for fintech startups while maintaining oversight.
Implement a sandbox model where innovative firms can test new services under controlled conditions.
B. Blockchain & Distributed Ledger Technology
Provide clearer guidance on how broker-dealers can use blockchain for clearing, settlement, and recordkeeping.
Update Regulatory Notice 21-25 on digital assets to provide more flexibility for using blockchain in securities markets.
C. AI & Automated Trading Compliance
Introduce modernized compliance rules for AI-based order execution and risk management.
Provide guidance on how AI-driven trading models comply with best execution rules.
4. Addressing Gaps, Risks, and Other Challenges in Market Regulation
As markets, products, services, and technology evolve, new risks and regulatory gaps emerge that FINRA should address to better protect investors while maintaining market integrity. Below are four key areas where additional guidance or standards are needed to close regulatory loopholes and modernize oversight.
A. Enhancing Market Manipulation Detection & Enforcement
Market manipulation tactics, including naked short selling, spoofing, layering, and abusive algorithmic trading, have outpaced existing regulatory enforcement mechanisms. Key regulatory gaps that FINRA should address include:
Increased transparency of synthetic short positions and derivatives-based manipulation.
Require real-time disclosure of synthetic shares, swaps, and total market exposure to short positions.
Enhance Regulation SHO (Rule 204) compliance to ensure timely close-outs of short positions.
Better tracking of Failures to Deliver (FTDs) and off-exchange trades.
Increase reporting frequency for FTDs and short interest from bi-monthly to daily.
Mandate broker-dealers to report all FTDs linked to derivatives and swaps.
Tightening loopholes that allow manipulation through dark pools and internalization.
FINRA should require public disclosure of off-exchange (dark pool) trading volume in real-time.
Prevent market makers from routing retail trades into internalized liquidity pools before public exchanges.
B. Hybrid Market Structures (Crypto + Traditional Assets) & Digital Asset Regulations
With the increasing intersection of traditional finance (TradFi) and decentralized finance (DeFi), FINRA should provide clearer rules on how broker-dealers can handle crypto-related securities and hybrid financial products. Key areas of concern:
Defining whether crypto trading platforms need to register as broker-dealers.
FINRA should clarify which crypto assets fall under its jurisdiction and which require SEC or CFTC oversight.
Provide guidelines on custody and liquidity requirements for digital assets.
Establishing risk management standards for broker-dealers engaging with crypto markets.
Introduce clear rules on margin, leverage, and collateral requirements for crypto-backed securities.
Require disclosure of crypto exposure in regulatory filings.
Regulating tokenized securities and blockchain-based settlement systems.
Provide guidance on how tokenized securities can be traded within existing regulatory frameworks.
Address clearing and settlement issues for blockchain-based transactions.
C. Investor Protections in Emerging Financial Products (SPACs, Options, OTC, ETFs, etc.)
New investment products, including SPACs (Special Purpose Acquisition Companies), leveraged ETFs, and complex derivatives, pose risks that FINRA should address to prevent investor harm. Areas needing modernization:
SPAC Regulations & Retail Investor Protections
Increase transparency of fees, dilution risks, and sponsor incentives in SPAC filings.
Prevent misleading marketing of SPACs that suggests they are “safe” investments.
Option Trading & Margin Regulation for Retail Investors
Review option approval processes to ensure retail traders understand risks before engaging in complex strategies.
Require brokers to provide real-time risk analysis for margin accounts to prevent unexpected liquidations.
Strengthen oversight of penny stock promotions and misinformation campaigns.
Mandate better disclosure requirements for OTC-listed companies to reduce fraud.
D. Strengthening Surveillance of Trading Halts & Market-Wide Circuit Breakers
The lack of clear rules and transparency in trading halts, particularly in OTC and small-cap securities, has led to market disruptions and loss of investor confidence (e.g., MMTLP’s U3 halt). Areas requiring reform:
Trading Halts (U3 Halt Rules & OTC Suspensions)
Introduce a formal appeals process for investors affected by unjustified halts.
Require brokers to notify investors of pending halts with sufficient time to act.
Circuit Breakers & Liquidity Controls for Volatile Stocks
Adapt market-wide circuit breakers to better handle high-volatility securities.
Implement liquidity rules that ensure order execution priority for retail investors during extreme price swings.
Conclusion
By addressing these regulatory gaps and risks, FINRA can create a more transparent, fair, and efficient market structure. The focus should be on:
✅ Closing loopholes that enable market manipulation through short selling and dark pools.
✅ Providing clarity on crypto and digital asset regulations to align with modern finance.
✅ Enhancing investor protections for SPACs, options, and OTC securities to prevent fraud and financial harm.
✅ Reforming trading halt rules to ensure market integrity and prevent unjustified suspensions.
FINRA must take a proactive approach to market modernization to ensure that regulatory frameworks evolve alongside financial markets and technology while prioritizing investor protection and market stability.
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Dustin Hite Comment On Regulatory Notice 25-04
FINRA’s rules should be modernized to address economic costs, evolving markets, technology advancements, and regulatory inefficiencies. Below are key areas for modernization, including specific rules, guidance updates, and regulatory overlaps that warrant attention.
1. Focus Areas for Modernizing FINRA Rules
Several FINRA rules are outdated, overly burdensome, or fail to account for modern trading environments and technologies.
A. Short Selling & Market Transparency Rules
Rule 4320 – Short Sales in OTC Equity Securities
This rule should be revised to increase reporting requirements for OTC short positions and provide real-time data transparency to prevent market manipulation (e.g., MMTLP scenario).
Expand close-out requirements under Regulation SHO (Rule 204) to eliminate extended failures to deliver (FTDs).
Rule 4560 – Short Interest Reporting
Require daily reporting (instead of semi-monthly) for more transparency on short interest levels.
Mandate reporting of total synthetic shares created through swaps or derivatives.
B. Market Halt & Trading Suspension Rules
Rule 6440 – Trading and Quotation Halt in OTC Equity Securities
FINRA should reform U3 halt procedures to prevent unjustified suspensions (e.g., MMTLP).
Introduce a formal appeals process so investors can challenge trading halts.
Rule 11892 – Clearly Erroneous Transactions
Update criteria for trade cancellations to prevent market makers from abusing “erroneous” cancellations to avoid fulfilling transactions that move against them.
C. Market Making & Order Handling
Rule 5210 – Marking of Customer Orders
Require brokers to identify and report synthetic share orders created through market maker internalization.
Rule 5320 – Prohibition Against Trading Ahead of Customer Orders
Strengthen enforcement to prevent brokers from routing orders through dark pools before executing retail trades.
2. FINRA Interpretations & Guidance Needing Updates
FINRA should modernize guidance in several areas where regulatory gaps, risks, and inefficiencies exist.
A. Naked Shorting & Failures to Deliver (FTDs)
FINRA should clarify guidance on how synthetic shorts and FTDs are addressed under Regulation SHO.
Provide more frequent public disclosures of FTD data, including off-exchange (dark pool) failures.
B. Alternative Trading Systems (ATS) & Dark Pools
FINRA should enhance transparency requirements for dark pool order routing, ensuring brokers prioritize best execution for retail orders rather than internalizing trades.
C. Special Purpose Acquisition Companies (SPACs)
Guidance should clarify how retail investors in SPACs are protected from dilution, insider trading, and hidden fees.
D. Crypto & Digital Asset Regulations
Clarify whether crypto trading platforms require broker-dealer registration.
Establish rules on custody and liquidity requirements for digital assets.
3. FINRA Rules That Should Be Modernized to Support Innovation
To encourage innovation and modern technology, FINRA should focus on removing unnecessary barriers while ensuring investor protection.
A. Streamlining Broker-Dealer Registration for Fintech Startups
Rule 1014 – Membership Application Process
Simplify the registration process for fintech startups while maintaining oversight.
Implement a sandbox model where innovative firms can test new services under controlled conditions.
B. Blockchain & Distributed Ledger Technology
Provide clearer guidance on how broker-dealers can use blockchain for clearing, settlement, and recordkeeping.
Update Regulatory Notice 21-25 on digital assets to provide more flexibility for using blockchain in securities markets.
C. AI & Automated Trading Compliance
Introduce modernized compliance rules for AI-based order execution and risk management.
Provide guidance on how AI-driven trading models comply with best execution rules.
4. Addressing Gaps, Risks, and Other Challenges in Market Regulation
As markets, products, services, and technology evolve, new risks and regulatory gaps emerge that FINRA should address to better protect investors while maintaining market integrity. Below are four key areas where additional guidance or standards are needed to close regulatory loopholes and modernize oversight.
A. Enhancing Market Manipulation Detection & Enforcement
Market manipulation tactics, including naked short selling, spoofing, layering, and abusive algorithmic trading, have outpaced existing regulatory enforcement mechanisms. Key regulatory gaps that FINRA should address include:
Increased transparency of synthetic short positions and derivatives-based manipulation.
Require real-time disclosure of synthetic shares, swaps, and total market exposure to short positions.
Enhance Regulation SHO (Rule 204) compliance to ensure timely close-outs of short positions.
Better tracking of Failures to Deliver (FTDs) and off-exchange trades.
Increase reporting frequency for FTDs and short interest from bi-monthly to daily.
Mandate broker-dealers to report all FTDs linked to derivatives and swaps.
Tightening loopholes that allow manipulation through dark pools and internalization.
FINRA should require public disclosure of off-exchange (dark pool) trading volume in real-time.
Prevent market makers from routing retail trades into internalized liquidity pools before public exchanges.
B. Hybrid Market Structures (Crypto + Traditional Assets) & Digital Asset Regulations
With the increasing intersection of traditional finance (TradFi) and decentralized finance (DeFi), FINRA should provide clearer rules on how broker-dealers can handle crypto-related securities and hybrid financial products. Key areas of concern:
Defining whether crypto trading platforms need to register as broker-dealers.
FINRA should clarify which crypto assets fall under its jurisdiction and which require SEC or CFTC oversight.
Provide guidelines on custody and liquidity requirements for digital assets.
Establishing risk management standards for broker-dealers engaging with crypto markets.
Introduce clear rules on margin, leverage, and collateral requirements for crypto-backed securities.
Require disclosure of crypto exposure in regulatory filings.
Regulating tokenized securities and blockchain-based settlement systems.
Provide guidance on how tokenized securities can be traded within existing regulatory frameworks.
Address clearing and settlement issues for blockchain-based transactions.
C. Investor Protections in Emerging Financial Products (SPACs, Options, OTC, ETFs, etc.)
New investment products, including SPACs (Special Purpose Acquisition Companies), leveraged ETFs, and complex derivatives, pose risks that FINRA should address to prevent investor harm. Areas needing modernization:
SPAC Regulations & Retail Investor Protections
Increase transparency of fees, dilution risks, and sponsor incentives in SPAC filings.
Prevent misleading marketing of SPACs that suggests they are “safe” investments.
Option Trading & Margin Regulation for Retail Investors
Review option approval processes to ensure retail traders understand risks before engaging in complex strategies.
Require brokers to provide real-time risk analysis for margin accounts to prevent unexpected liquidations.
OTC Market Transparency & Pump-and-Dump Prevention
Strengthen oversight of penny stock promotions and misinformation campaigns.
Mandate better disclosure requirements for OTC-listed companies to reduce fraud.
D. Strengthening Surveillance of Trading Halts & Market-Wide Circuit Breakers
The lack of clear rules and transparency in trading halts, particularly in OTC and small-cap securities, has led to market disruptions and loss of investor confidence (e.g., MMTLP’s U3 halt). Areas requiring reform:
Trading Halts (U3 Halt Rules & OTC Suspensions)
Introduce a formal appeals process for investors affected by unjustified halts.
Require brokers to notify investors of pending halts with sufficient time to act.
Circuit Breakers & Liquidity Controls for Volatile Stocks
Adapt market-wide circuit breakers to better handle high-volatility securities.
Implement liquidity rules that ensure order execution priority for retail investors during extreme price swings.
Conclusion
By addressing these regulatory gaps and risks, FINRA can create a more transparent, fair, and efficient market structure. The focus should be on:
✅ Closing loopholes that enable market manipulation through short selling and dark pools.
✅ Providing clarity on crypto and digital asset regulations to align with modern finance.
✅ Enhancing investor protections for SPACs, options, and OTC securities to prevent fraud and financial harm.
✅ Reforming trading halt rules to ensure market integrity and prevent unjustified suspensions.
FINRA must take a proactive approach to market modernization to ensure that regulatory frameworks evolve alongside financial markets and technology while prioritizing investor protection and market stability.
Regards,
D. Hite