Online trading major Interactive Brokers LLC has agreed to pay a $475,000 fine as part of a settlement with Nasdaq.
This matter arose out of an investigation initiated by Nasdaq Enforcement based on referrals received by Nasdaq MarketWatch.
As a result of its investigation, Nasdaq Enforcement found that between January 1, 2020 and June 2, 2021 (the “Relevant Period”), the company improperly processed five corporate actions due to a combination of system and oversight deficiencies, in violation of Nasdaq General Rule 9, Sections 20(a) and 1(a).
Additionally, in certain scenarios, Interactive Brokers’ risk management controls and supervisory procedures were not reasonably designed to prevent the entry of erroneous orders, in violation of Section 15(c)(3) of the Securities Exchange Act of 1934 (“Section 15 ( (c)(3)”); Rules 15c3-5(c)(1)(ii); and Nasdaq General Rule 9, Sections 20(a) and 1(a).
During the review period, Interactive Brokers used three independent data vendors to source information about corporate actions. The company’s written supervisory procedures (“WSP”) required confirmation of a company action from at least two of the three data sources used by the company. The company used an automated system to verify and process corporate actions for securities in customer accounts based on these data sources.
If two data sources matched, the system automatically processed the corporate action and updated customer accounts accordingly. If data sources provided conflicting information or only one data source corroborated the corporate action, then the matter would be escalated for manual review by the company’s corporate action team.
Two deficiencies delayed or prevented the Company from properly handling five corporate actions during the Relevant Period. As a result, the Company sent market orders at incorrect prices based on information prior to the reversal of the split in some cases and, in two cases, clients were able to sell shares they did not own.
First, the company’s WSPs and oversight systems were not logically designed. Specifically, the WSPs did not contain information about what manual review should entail when an issue is escalated, or what actions should be taken to verify an enterprise action originating from a single data vendor or whether information from multiple vendors was in conflict.
Additionally, the firm did not adequately monitor pre-market trading following a corporate action to verify that it properly processed the corporate action. Additionally, the company did not have reasonably designed procedures to prevent customers from transacting based on inaccurate account information if the company did not process a corporate action in a timely manner.
The company failed to address these gaps in its supervisory processes, despite having instances where corporate actions could not be automatically confirmed. These failures resulted in the following three inventory reversals not being processed in time.
Second, Interactive Brokers failed to timely address a known system problem that rejected pre-approved reverse stock splits from taking effect (the “Rejection Issue”). The company’s corporate action systems would revoke the approval of corporate actions that had been confirmed by mapped data supplier sources if one of those data suppliers sent a subsequent notification about the corporate action.
The company became aware of this issue in or around July 2020, and fully remedied the issue in June 2021. However, the company did not implement reasonable protocols in the interim to prevent the Rejection Subject from revoking pre-approved corporate actions, resulting in a delay in processing by the company of two reverse stock splits.
During the relevant period, the company used certain incorrect order checks on guarantees, including a reference price filter. The firm’s reference price filter calculates the maximum price deviation from the reference price at which the firm will allow a client order to be routed for possible execution (the “Allowed Move”) for order orders.
The Permitted Movement for Equity Options is calculated by taking the reference price and adding a certain permitted percentage change in the premium of the security and a certain permitted percentage change in the price of the underlying security.
The Interactive Brokers reference price used for the warrants was the midpoint of the national best bid/offer (“NBBO”). If the midpoint of the NBBO was not available, the reference price was calculated based on, among other inputs, certain Greek collateral values and the current and previous closing price of the underlying stock (collectively, the “Backup Inputs”).
During the Relevant Period, if any of the reserve inputs were missing, no reference price was calculated and the order was not limited to the price.
The company then refined its reference price calculations so that the company’s price filters calculate and use a theoretical fair value to calculate price caps for the warrants in the absence of recent trading data.
On October 1, 2020, Interactive Brokers initiated a limit order on the Nasdaq that resulted in the execution of a purchase of 200 shares of a listed company’s warrants. These shares were executed at $3.25, which was 124% away from the previous day’s close. Interactive Brokers’ system could not calculate a reference price because there was no sell-side liquidity available at the time the order was placed and the additional information needed to calculate a backup reference price was missing. Therefore, the company did not set an upper limit on the price of the order and routed it at the limit price specified by its customer. In response to the company’s CE filing, Nasdaq decided to take down the trade.
In addition to the fine, Interactive Brokers agreed to a censure.