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FINRA issued Regulatory Notice 16-19 in an effort to encourage firms to review their practices regarding stop orders. Registered representatives often recommend stop orders as a tool for managing market risk. Investors use stop sell orders to protect profit position in the event a stock’s price declines and stop buy orders if they have a short position to limit losses in the event a stock’s price increases. Once stop orders are triggered, they become market orders, which are inherently risky, especially in volatile market conditions.
Because an investor’s use of stop orders during volatile market conditions can be risky, Regulatory Notice 16-19 encourages firms to: (1) educate registered representatives on advising their customers regarding the use of stop orders; (2) disclose risks prominently where investors are able to enter stop orders directly online; (3) review their customer base to determine whether any safeguards should be put into effect around the availability and use of stop orders; and (4) consider whether systematic safeguards around the use of specific order types is appropriate.
By educating registered representatives and customers on the use of stop orders, firms should, at a minimum, disclose the following: stop prices are not guaranteed execution prices; stop orders may be triggered by a short-lived, dramatic price change; and sell stop orders may exacerbate price declines during times of extreme volatility. Firms should also consider placing a limit price on a stop order to help manage these risks and improving communication with their customers regarding market conditions.
In addition to determining whether current disclosures are sufficient, firms should consider whether any systematic safeguards would be appropriate. With regard to stop orders, firms should consider: prominent disclosures at the time of order entry, controls on the use of stop orders that do not carry a limit price, special terms on stop orders, and expiration of good-til-cancelled stop orders. Given the recent periods of volatility in the U.S. equity markets, we encourage our broker dealer clients to implement the disclosures and systematic safeguards related to stop orders that are referenced in Regulatory Notice 16-19.