Regulatory Roundup: Algorithmic Trading Controls: Best Practices and Two Landmark Cases

Analysis

Even 20 years after their mainstream adoption, algorithmic trading continues to challenge regulators and compliance teams. It's not just that it is inherently complex, but the pace of change and lightning-fast incorporation of emerging technologies demand constant vigilance. Last month, the U.K. Financial Conduct Authority (FCA) published a multi-firm review of algorithmic trading controls across principal trading firms, identifying where firms perform well and where they don't.  

For this month's write-up, I'll examine the key findings from the FCA's report and cross-check them against two landmark cases of algorithmic control failures.

Key Takeaways

• The FCA's multi-firm review of algorithmic trading controls highlights that strong governance, technical compliance expertise and robust algorithmic controls are essential for managing risks in algorithmic trading.
• Landmark failures like Knight Capital underscore the critical need for thorough testing, documentation and real-time surveillance to prevent costly errors.
• Manipulation cases such as "The Hammer" reveal that basic algorithms can still pose significant market abuse risks if oversight and surveillance are lacking. 

The FCA's Review of Algorithmic Trading Controls at Principal Trading Firms 

The FCA reviewed 10 principal trading firms, focusing on MiFID II's RTS6 rules. The report doesn't introduce any new rules but instead reinforces best practices. Key best practices include: 

• Technically proficient compliance staff who can review and challenge algorithmic trading processes.
• Clear inventories of who owned and was approved to operate each algorithm, including applicable markets and risk parameters.
• Robust governance, with ongoing communication between compliance and developers, plus feedback on market activity.
• Regular simulation tests with updated stress scenarios and market conditions.
• Controlled algorithm deployment, such as retesting as if it was a new model when it is deployed in a new market.
• Well defined pre-trade controls, like executing them at the internal server level before orders can leave the internal environment.
• Calibrated surveillance systems tailored to algorithmic trading, with random reviews of closed alerts. 

Algorithmic Trading Gone Wrong: How to Lose $160,000 Per Second  

Perhaps the most dramatic case of algorithmic trading failure is the Knight Capital incident. A flawed deployment of new code caused their systems to send 4 million unintended orders into the market. Over 45 minutes, Knight Capital acquired massive positions across approximately 150 stocks resulting in $460 million USD in losses. The incident was a huge wakeup call to the industry and helped define many of the best practices that the FCA report mentions.
 

The SEC's detailed investigation revealed failings across nearly every "best practice" mentioned above. Core issues included:

• A chaotic deployment process that allowed unreviewed code, manual copying into production environments and poor version control.
• Lack of routine testing or documentation that could have caught the issue.
• No real-time risk and safety checks or fail-safes. 97 system generated emails went unacted until after market open.
• No surveillance alerts to flag the unusual trading activity, which continued unchecked for far too long.

Although the trigger was a software bug, the real failure was in Knight's lax compliance processes and risk control.

"The Hammer": An Algorithmic Trading Manipulation Case Study

While Knight's case stemmed from an error in the algorithm, what about using algorithms for market manipulation? That’s not new either. Back in 2007, three traders used an algorithm (internally nicknamed "The Hammer") to move settlement prices in NYMEX crude oil, heating oil and gasoline futures by executing concentrated trades just before and during the close. The CFTC described the tactic as "banging the close/marking the close," designed to move the settlement price and profit on their Trade at Settlement (TAS) positions.   

The purpose of "The Hammer" was to both flood and gain higher priority in the order queue within the short sensitive window before settlement. In the manipulators' own words, it was meant to "really bully" the market and control the settlement price. Compared to today’s models, "The Hammer" was incredibly basic, but its catchy name helped generate greater awareness of how trading has changed and the new challenges that came with it. 
 

September 2025 Capital Markets Regulatory Updates

23 September 2025: The CFTC launched an initiative to explore tokenized collateral in derivatives, seeking public input by Oct 20 as part of its crypto modernization efforts.

17 September 2025: The FCA proposed bringing crypto firms fully under U.K. regulations by adapting existing financial rules. In a new consultation paper, the FCA set out a framework to apply traditional requirements to crypto-asset businesses "on a proportionate basis."

15 September 2025: The French, Austrian and Italian financial markets authorities are called for a stronger European crypto-asset framework to improve supervision, investor protection, and competitiveness, based on MiCA lessons.

5 September 2025: The SEC launched a Cross-Border Task Force to target fraud by overseas-listed companies, focusing on "pump-and-dump" schemes and gatekeeper scrutiny.

4 September 2025: The CFTC concluded an enforcement sprint led by Acting Chairman Pham, issuing six orders against 10 firms for compliance failures, resulting in $8.3M in penalties and remediation commitments.

4 September 2025: Japan's Financial Services Agency (FSA) proposed to classify cryptocurrencies as securities under the Financial Instruments and Exchange Act (FIEA) in a major regulatory shift, aiming to protect retail investors and crack down on unregistered operators.

3 September 2025: The CFTC cleared crypto prediction platform Polymarket to launch in the United States via a no-action letter, allowing compliant prediction markets after previous setbacks.

2 September 2025: The Securities and Exchange Board of India (SEBI) introduced stricter intraday position limits for index options trading. Each broker or entity's net intraday positions in equity index options will be capped at ₹5,000 crore. The gross intraday limit remains ₹10,000 crore per direction. SEBI is mandating stock exchanges to take at least four random snapshots of intraday positions to enforce these limits.

2 September 2025: The U.S. SEC and CFTC issued a joint statement clarifying that exchanges registered with them can facilitate trading of certain spot crypto asset products.

Latest Fines and Enforcement Actions

• The SEC charged a former Two Sigma portfolio manager with fraud for manipulating algorithmic trading models to boost his pay, causing $165 million in client portfolio distortions (which the firm repaid to clients).
• The SEC and FINRA charged two individuals in a $100 million Chinese pump-and-dump stock scheme involving millions of shares of Ostin Technology Group (OST). At its peak, OST's market cap surged from $22 million to over $1 billion before crashing 94%, leaving retail investors with huge losses.
• ASIC announced a record 240 million AUD settlement with ANZ Bank for "widespread misconduct" across its operations. ANZ admitted to four major failures, including unconscionable trading, ignored hardship requests, false statements and improper fees.
• The CFTC ordered a Colorado trader and his firm Flatiron Futures Traders to pay a $200,000 penalty for spoofing in equity index futures.
• Three U.K. social-media "finfluencers" made their first court appearance in an FCA-led crackdown on illegal financial promotions. They were each charged with unlawfully promoting high-risk forex CFD investments to the public without authorization.
• Swedish authorities arrested nine people on suspicion of insider trading ahead of takeover bids for two Stockholm-listed companies. Investigators allege the suspects traded large volumes of Tethys Oil and Fortnox stock in 2024–2025 based on leaked deal information.
• The CFTC sanctioned Shinhan Securities Co. $212,500 for illegal wash trading on the NYMEX. Shinhan agreed to pay a $212,500 civil penalty and to cease and desist further violations.
• The SEC announced that a jury found an individual liable for securities fraud and manipulative trading, including using Twitter to promote stocks he secretly sold for profit.
• South Korea's new stock-manipulation task force raided 10 sites and uncovered a ₩100 billion ($72 million) scheme in which seven elite investors used sham buy orders and synchronized trades to inflate a thinly traded KOSPI stock over 21 months, marking the task force's first major victory against pump-and-dump rings. 

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