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Conflict Of Interest Disclosure For Prop Vs Client Flow

conflict-of-interest-disclosure-for-prop-vs-client-flowsource

Use when a broker-dealer trades proprietarily in US equities alongside unexecuted customer orders, under FINRA Rule 5320 Manning: the no-knowledge information barrier, negative consent and minimum price improvement.

Domain
Regulatory Compliance
Version
2.0.0
Reading
6 min
Hands off to
5
Handed off from
0
License
Apache-2.0
CoversFINRASEC Rule 605/606Generic Broker Engine

When to Use

Use this skill in broker-dealer architectures or multi-desk firms that run proprietary trading alongside customer order handling in US equities. FINRA Rule 5320 prohibits a member that holds an unexecuted customer order from trading the same security on the same side of the market for its own account at a price that would satisfy that customer order, unless it immediately thereafter fills the customer up to size at the same or better price — or unless one of the Rule's supplementary-material exceptions applies.

The direction of that test is the single most-often inverted piece of logic in Manning implementations:

Held customer order A proprietary trade "satisfies" it at Permitted proprietary prices
BUY limit $150.00 a purchase at $150.00 or lower $150.01 or higher (limit + Rule 5320.06 increment)
SELL limit $150.00 a sale at $150.00 or higher $149.99 or lower (limit − Rule 5320.06 increment)

If your gate blocks the firm from paying up over a customer buy limit, it has the rule backwards: it is permitting the actual front-running and blocking the harmless trades.

When NOT to Use

  • Non-US-equity instruments. Rule 5320 applies to NMS stocks and OTC Equity Securities. It does not reach options, futures or fixed income.
  • Non-US jurisdictions. The EU/UK analogue is a misuse-of-information prohibition with different mechanics and no share/value opt-out (Commission Delegated Regulation (EU) 2017/565 Art. 67; UK COBS 11.3.5A R). Do not port the 10,000-share threshold outside the US — it has no counterpart there. See mifid-ii-algo-trading-compliance-eu.
  • As the firm's whole Rule 5320 programme. This engine covers the price test and the .01/.02/.05/.06 exceptions. It does not implement the riskless-principal (.03) or ISO (.04) exceptions, does not perform the customer fill the Rule requires when the firm does trade at a satisfying price, and does not discharge the written order-handling procedures required by Rule 5320.07.
  • As market-abuse surveillance. Trading ahead of a third party's order flow is a different problem — see wash-trade-and-spoofing-self-detection and eu-market-abuse-regulation-mar-surveillance.

Prerequisites

  • Order capacity tagging: principal vs. agency, carried to the venue on FIX OrderCapacity(528) (with OrderRestrictions(529)). Rule80A(47) is deprecated as of FIX 4.3 — do not build new integrations on it.
  • A snapshot of the firm's unexecuted customer orders in the security, with limit price, size and the barrier/desk that holds them.
  • Per-customer reference data: FINRA Rule 4512(c) institutional-account status, whether the Rule 5320.01 written disclosure was given at account opening and annually thereafter, and whether the customer opted in to Rule 5320 protection.
  • An attested inventory of which desks sit behind an effective information barrier — a distinct info_barrier_id string is a label, not a control.
  • Optionally, the current inside spread, needed for the Rule 5320.06 increment on sub-$1.00 and OTC securities.

Workflow

  1. Order Ingestion: Build a PropOrder with symbol, side, quantity, price, info_barrier_id, security_type (NMS_STOCK / OTC_EQUITY), trading_unit_type and barriers_effective.
  2. Gate the Order: Call evaluate_prop_order and branch on is_approved, or call enforce_prop_order, which raises Rule5320ViolationError so a missing branch cannot leak an order to the market.
  3. Fail Closed on Bad Input: An unrecognised side, a non-finite or non-positive price, a non-positive quantity, or a client order that cannot be parsed returns INVALID_ORDER_PARAMETERS and is not approved. A compliance gate that cannot evaluate an order must not pass it.
  4. Price Test with Minimum Price Improvement: Every same-symbol, same-side customer order is compared using the direction table above, widened by the Rule 5320.06 increment: $0.01 for NMS stocks at or above $1.00, and the lesser of the tier increment or half the inside spread otherwise. A sub-penny "improvement" over a customer limit does not clear the Rule.
  5. Exception Audit, per client order — and note that these are per order, not per audit:
    • Odd lot (.05): a customer order for less than one round lot does not attach the obligation.
    • No-knowledge (.02): distinct, effective information barriers between the desk holding the customer order and the proprietary desk. For OTC Equity Securities this exception is not available to the market-making desk — only to a non-market-making unit.
    • Large order / institutional, on negative consent (.01): available where the account is institutional under Rule 4512(c), or the order is 10,000 shares or more and at least $100,000 in value — both, not either. It requires the written disclosure to have been given, and is lost the moment the customer opts in.
  6. Evaluate Every Order Before Approving: An exception that covers one resting customer order says nothing about the next one. The engine approves only when every matching order is non-conflicting or excepted, and reports all conflicts in result.conflicts.
  7. Violation Resolution: Block the proprietary order, or execute the customer order up to its size at the same or better price contemporaneously, as Rule 5320(a) requires. Persist the full ConflictAuditResult for supervisory review.

Full procedure: see references/workflows.md. Standards reference: see references/standards.md. Printable pre-flight checklist: see assets/checklist.md.

Common Pitfalls

  • Inverting the Price Test: Treating a proprietary buy above a customer's buy limit as the conflict. The violation is buying at or below it — that purchase is the fill the customer's resting order should have received.
  • Approving on the First Exception Found: Returning APPROVED as soon as one resting customer order qualifies for the no-knowledge exception, without checking the rest of the book. The order behind it, held by the same desk, is then front-run silently.
  • Failing Open on Unparseable Input: A side string of "buy" or "B" matching neither branch of a price test and falling through to "no conflict". Normalise, then reject what will not normalise.
  • Reading the .01 Exception as an Opt-Out Flag: Rule 5320.01 works by negative consent — the firm must have disclosed and given the customer a meaningful opportunity to opt in. Absence of an opt-in is not the same as the presence of a valid disclosure; model both facts.
  • Loosening the Large-Order Threshold to OR: 10,000 shares or more unless less than $100,000 in value means both conditions. A 10,000-share order in a $5 stock is not a large order for this purpose.
  • Blanket No-Knowledge for OTC Market Making: Rule 5320.02 withholds the exception from the market-making desk in OTC Equity Securities. An NMS-stock configuration silently applied to OTC flow over-approves.
  • Sub-Penny Price Improvement: Buying at $150.001 over a $150.00 customer buy limit does not satisfy the order, but it does not clear the Rule 5320.06 increment either.
  • Sharing Order-Book State Across Desks: Letting a proprietary algorithm query the firm's customer order book at all, then claiming the no-knowledge exception. The exception rests on the barrier working, not on it being declared.
  • Binary Float Price Comparison: Rule 5320 turns on exact equality with a customer limit price. Compare in Decimal; the engine converts floats through str() for that reason.
  • Un-tagged Capacity: Sending orders without OrderCapacity(528), leaving the audit trail unable to distinguish principal from agency flow.

Verification

  • Instantiate PropVsClientConflictEngine with a pending 500-share retail CLIENT buy limit for AAPL at $150.00 on DESK_A. Submit a PROP buy at $150.00 from DESK_A: expect FINRA_RULE_5320_TRADING_AHEAD. Submit a PROP buy at $140.00: expect the same violation. Submit at $150.005: still blocked, because the improvement is below the Rule 5320.06 increment. Submit at $150.01: approved, with no exception recorded — clearing the increment means there was no conflict to except.
  • Set distinct info_barrier_id values and confirm NO_KNOWLEDGE_BARRIER; then set security_type=OTC_EQUITY with trading_unit_type=MARKET_MAKING and confirm the exception is withdrawn.
  • Put two resting client orders in the book, one behind a barrier and one on the proprietary desk, and confirm the order is still blocked.
  • Submit a prop order with side="B" and with a NaN price; confirm both are rejected rather than passed.
  • Run python -m unittest discover -s skills/conflict-of-interest-disclosure-for-prop-vs-client-flow/scripts and confirm all tests pass.

Verify it, from the repository root

python -m unittest discover -s skills/conflict-of-interest-disclosure-for-prop-vs-client-flow/scripts

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