IM Catches Fire, Raises Concerns

Even as Wall Street continues to struggle to meet electronic archiving requirements, a new application of instant messaging (IM) is spreading like wildfire, catching regulators off-guard and troubling compliance officers: Traders are transmitting securities orders via the medium that not long ago was known mainly as a chat and gossip channel or schoolkids.

“Traders are using IM at home, and it has seamlessly migrated into their professional lives,” says Furqan Nazeeri, CEO of Pivot Solutions, developer of a system called IMTRADER that converts instant into trade orders. “IM use [in trading] has grown explosively in the last few years. This is one of the hottest trends on Wall Street.”

“Traders are using IM at home, and it has seamlessly migrated into their professional lives,” says Furqan Nazeeri, CEO of Pivot Solutions, developer of a system called IMTRADER that converts instant into trade orders. “IM use [in trading] has grown explosively in the last few years. This is one of the hottest trends on Wall Street.”

Hot or not, many attendees at a Security Traders Association (STA) conference in Washington, D.C. earlier this month expressed misgivings about the practice and openly requested regulatory guidance. “A lot of us struggle with the [IM and e-mail] review process,” said Mark Madoff, co-director of equities at Madoff Investment Securities in New York and moderator of a panel discussion on regulations, including IM and e-mail retention. “Now we are starting to see orders being delivered via IM. What should we be looking out for?”

One trader in the audience told the panel that he has clients demanding that they be allowed to use IM to transmit orders. But, in the wake of recent scandals and tightened regulatory requirements that client communications be monitored and archived, securities industry executives have grown sensitive to the interplay between the burgeoning messaging technology and existing rules. “It is a new way of doing business,” said the STA attendee. “Please give us some guidance.”

Richard Wallace, the National Association of Securities Dealers’ chief counsel and VP of market regulation, had an unsettling response: “You could have a huge books-and-records problem if someone front-runs the order based on the IM. The whole issue is a tremendous problem unless your books and records reflect what is really going on.”

IM on the trading desk has taken off only in the last few years, according to Nazeeri, whose company, Pivot Solutions, was spun off in 2004 by Boston-based Eze Castle Integration, a technology developer and outsourcer for hedge funds and other institutions. The IMTRADER product allows for trading in a manner compliant with Securities and Exchange Commission rules, says Nazeeri, by turning instant messages into the standard FIX format for transmission between the buy side and sell side. Nazeeri estimates that more than 80 percent of Wall Street firms now use IM, and of those, some 80 percent use America Online’s instant messaging platform, AIM, with which IMTRADER is compatible as a result of a strategic alliance between the companies.

Same as E-mail

As a practical matter, IM falls under the same SEC regulations as e-mail, meaning that all communications must be retained and archived in a compliant manner. Trade orders via IM pose some special risks—including front-running of orders, which disadvantages clients seeking the best price—if a trader has access to messages that are not logged and archived. Surprisingly, however, the specific issue of order delivery via IM has been slow to appear on the SEC’s radar screen. STA panelist Eric Swanson, assistant director of market oversight in the SEC’s office of compliance inspections and examinations, May 15, 2006 What Makes Markets www.securitiesindustry.com IM Catches Fire, Raises Concerns COMPLIANCE Furqan Nazeeri tutions. messages into trade orders. admitted that “order delivery over IM is a new issue for me.” SEC commissioner Cynthia Glassman, in a conversation at a reception following the panel, conceded, “The technology is getting ahead of us.”

Nazeeri agrees that technology “is moving faster than Washington” but adds that vendors are rapidly developing solutions like IMTRADER, which integrates directly into an order management system (OMS). “The trader typically has three monitors on the desktop,” he explains. “One is the OMS, one is Bloomberg, and the third is a screen containing IM messages. IMTRADER manages that third screen; we connect it to the OMS.”

Fast-moving though it may be, the technology has only selectively penetrated the institutional trading community. IMTRADER says it has more than 225 buy-side firms on its network, and 3 billion- plus shares have changed hands over it. The company counts such prominent firms as Instinet and Deutsche Bank as clients. Nazeeri says that the network encompasses a total of 1,400 institutional traders, but that barely scratches the surface of a universe of approximately 100,000. There are a handful of other competing solutions, but IMTRADER has the biggest user base.

Even if a firm has a system in place for logging and archiving IM orders, there are other ways that the practice can expose firms to risk. One stems from the high percentage of Wall Street firms that are using AOL’s AIM®, which is also dominant in the consumer market. If a trader has access to an IM network that is outside the company and its technological controls, “that could create a risk,” Nazeeri explains.

In any event, the availability of solutions like IMTRADER did not allay the concerns of traders at the STA conference. “Developing robust internal controls is easier said than done,” said Madoff. “Technology and instant messaging break down any physical wall you could build.”

Yet it is widely agreed that this hightech genie is out of the bottle for good, there is no turning back. “We are the PlayStation generation,” said Joseph N. Cangemi, managing director of Bank of New York Co.’s BNY Brokerage, referring to the popular Sony Corp. electronic games platform. “We grew up using instant messaging, and that is the way we communicate.”