Market Surveillance

6 Trends Impacting Retail Brokers & Surveillance Teams

In financial markets, change is constant – and arguably, no segment of the market has experienced more change than the retail industry. 

Among the surging volumes and volatility, there are a number of key developments that are shaping the retail space – and as a result, the ways in which they need to monitor for market abuse.

Here are some of the top trends in retail and what that means for surveillance teams looking to ensure investor protection:

Trading Cryptocurrency Has Risen in Popularity

Many retail firms are heavily involved in the trading of emerging products – especially crypto. While crypto brings unique opportunities for innovation and growth, retail brokers must balance the risk of exposure to high-profile financial crimes. 

Increased regulation within crypto markets is imminent, and most jurisdictions will look to implement a crypto regulatory framework. Firms will need to ensure they have surveillance systems that can integrate and manage the huge data loads (including high volumes of messages) that accompany the highly volatile nature of crypto markets. 

In addition, they must ensure that their surveillance solution provides coverage for suspicious activity and key crypto market risks that include:

  • Spoofing
  • Ramping
  • Momentum Ignition
  • Pump & Dumps
  • Insider Trading

Fractional Trading and Copy Trading Has Increased the Level of Trading Activity

The increasing availability of value-based trading (fractional volumes) has enabled smaller investors to get a taste of higher-priced securities. At the same time, the influence of social media has driven additional market engagement from individual investors. As a result, some of the newer trading platforms and retail firms are applying social media concepts to how their customers make and execute investment decisions. For example, features such as “copy trading” adopt the concept of “following” and “influencers” – a retail customer can ‘copy’ the investment strategy of another customer who shares details of their portfolio and performance.

Where firms offer these types of trading capabilities, they must also be mindful that there is the potential for frontrunning to occur. For retail brokers looking to uphold the integrity of their firm and protect investors, a surveillance system that can monitor for market manipulation behaviors such as frontrunning and trading ahead of significant price movements, volumes, or events is essential.

Regulators have also taken note of the shift in retail investor engagement in the markets, and while these new trading modes may attract new market participants and liquidity, they are likely to raise questions and cause concern for regulators. As such, retail firms must ensure that their surveillance system can adapt as trading flows and regulations change.

Younger Retail Investors Entering the Market Creates a New Trading Profile

With the onset of the COVID-19 pandemic, a new profile of younger investors became highly engaged in financial markets. This user base is social media savvy and driven by lower market prices, a hunt for yield, and a plethora of crypto ‘success’ stories in the media.

These accounts will tend to have a relatively small “wallet” – trading smaller volumes across a range of products and securities. Individually, these trades may not be statistically anomalous but together may represent a pattern of potential market abuse.

In order to effectively monitor this new subset, surveillance programs must be effective at monitoring for patterns of activity across a wide range of time and securities, be able to benchmark each account over time to identify their “normal” trading profile, and have the analytics that can identify when that profile significantly changes.

Retail Brokers are in the Regulatory Spotlight During Social Media Fueled Pump and Dumps

In early 2021, a series of Reddit posts, followed by additional social media amplification and memes, significantly drove up the share price of GameStop stock. In the end, those who invested in the stock on the later end were faced with significant losses – some in the thousands of dollars. In the media, the GameStop scenario has often been referred to as a “pump and dump” scheme and generated significant negative publicity. 

A recent case study carried out by the Australian regulator (ASIC) - Case Study of Pump & Dump in micro securities – found that 81% of accounts that participated in organized social media pumps realized a financial loss or zero benefits.​ Further, these schemes, which combined misleading social media postings with coordinated ‘momentum ignition’ strategies, generated losses of $6.3 million per month for retail investors over the review period.

Given the potential for a negative impact on individual market participants, there can be political sensitivity around these types of market excesses, especially in crypto, and regulators will respond quickly, particularly where smaller retail investors are impacted.

New Market Manipulation Tactics are Specifically Targeting Retail Trading Firms

As market abuse continues to evolve, recent manipulation strategies have been uncovered that appear to target the trading algos deployed by retail firms.  

The strategy uses a form of “spread squeeze” in a very illiquid security. Related parties simultaneously enter orders through another counterparty, which in many cases is a retail firm that trades wholesale/off-market on behalf of customers. 

Nasdaq Trade Surveillance recently shared a blog post (‘Squeezing the Spread’) to our client community (Knowledge Base) to better inform customers of the tell-tale signs of this type of manipulation and of the new alert being built to help detect it.

Regulatory Focus on Retail Brokers Will Not Slow Down

Regulatory focus on retail was recently amplified in the action taken by FINRA against an online brokerage firm, which resulted in a substantial monetary fine.

The regulator stated that from “February 2016 through November 2021, [the firm] failed to establish and maintain a supervisory system…related to detecting potentially manipulative trading by its customers.” 

Further, it stated that while the firm used multiple surveillance reports to identify the potential wash trades and mark the close activity, its parameters were heavily restricted to detect such fraudulent activities. (Note: The firm agreed to settle with FINRA without admitting or denying the accusations.)

Against the background of these trends, retail firms are likely to be exposed to increased regulatory risk as they navigate this shape-shifting marketplace. It is imperative that their trade surveillance systems and processes provide coverage as market abuse risks evolve and regulators continue to increase focus on the retail segment.



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