The issue of accuracy in IOIs is as old as the tool itself, which is used by upstairs desks to seek out contra-side flow. Broker-dealers send out IOIs through their own systems or those of vendors such as Tradeweb's Autex, Bloomberg and NYFIX. FINRA warned member firms that, "to the extent that they disseminate or use such services to communicate indications of interest, such indications must be truthful, accurate and not misleading."And when you are talking about IOIs for 10-15 million share blocks of SPY, there is always absolutely nothing wrong with that... Ever. Hopefully, the pattern of why ZH loves IOIs is starting to emerge. Bear with us for a few more months as we indulge exposing all the chicanery out there.
FINRA's warning focused, in particular, on firms' use of "natural" IOIs. The concern is that brokers, to elicit phone calls from buyside traders, may be playing fast and loose with the description of the flow they're pitching as natural IOIs. [5 million share SPY blocks for sale anyone, anyone??] Naturals historically are intended to represent agency orders a broker-dealer is working, although some sellside firms also include riskless principal trades and proprietary positions taken on to facilitate a customer order that the broker is now unwinding.
Perone noted that IOIs have gained more attention recently as buyside firms seek "to execute in size and the average execution size on the exchange markets and ATSs alike have generally decreased." He added that "the less reliable the information is in IOIs broadcast by firms themselves or through vendors, the less useful it is to those seeking to execute orders." Perone also noted that FINRA's Office of the Whistleblower, which was established in March, has an "open matter" that "includes alleged potential misrepresentations by a firm with respect to the use of IOIs." [Hey Jamie, you may want to slow down a little before you pay off that TARP in full].
IOIs have been a liquidity-sourcing tool for decades. But the search for the other side, as well as the quest for color, has increasingly resulted in a more elastic approach to IOIs. As a result, all "naturals" are not always natural. Brokers may not have the order behind the indication or it may be for a much smaller size. Some brokers may be fishing for information. [Ahem] However, by the time the buyside firm discovers this, it's too late because the trader has already picked up the phone and exposed his intentions. None of the IOI service providers police brokers' use of the naturals tag on IOIs.
Rounding out Regulatory Notice 09-28 on IOIs, FINRA alerted member firms that they could land into hot water if they run afoul of its guidance. False or misleading IOIs, FINRA said, could violate NASD Rule 3310 (Publication of Transactions and Quotations) and IM-3310 (Manipulative and Deceptive Quotations). It could also violate FINRA Rule 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices), NASD Rule 2210 (Communications with the Public) and the anti-fraud provisions of the federal securities laws.
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