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A rare glimpse into how Nasdaq polices markets

All-access pass inside Nasdaq's surveillance room

Tucked into a nondescript corporate office park in suburban Rockville, Maryland, is an unusual high-security operation: the Nasdaq's Market Watch facility, where teams of analysts are on duty 24 hours a day, monitoring global trading for hints of manipulation, high frequency violations or insider trading.

Although Nasdaq has its market site headquartered in New York's Times Square, the exchange's surveillance effort is based outside of Washington, D.C., for better access to the nation's financial regulators at the SEC and FINRA, as well as for the local tech and legal workforce.

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Nasdaq has never allowed a reporter into the facility, but granted CNBC rare all-day access to see how its analysts police the markets in real time.

"Our goal here is to find bad behavior, but it's also to deter bad behavior," said Ed Knight, Nasdaq's executive vice president and general counsel. "People need to know that we have the best people and in my view the best technology."

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The integrity of American stock markets has been in focus over the year since Michael Lewis published his book "Flash Boys," starting a national debate over whether some high speed trading abuses meant the markets are "rigged."

High-frequency trading is one part of what Nasdaq is monitoring in Rockville, and the exchange boasts that it can rewind trades at "the finest gradation of time imaginable" to watch trading, using what Nasdaq says are more than 200 technology patents to check the activity.

But analysts are also looking at more old fashioned fraud, and they run background checks on executives and board members of Nasdaq-listed firms looking for officials who have been involved in fraud or improper activity.

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Nasdaq says it processes 4 billion messages each day at the Maryland facility, using computer algorithms that analyze 35,000 parameters in real time, sending alerts to human analysts for review within two seconds of the unusual trades.

They're also monitoring Twitter and real time news events, and then running back the trading ahead of announcements to watch for patterns of insider trading.

"We're looking for abnormal behavior, something might indicate insider trading, something that might indicate manipulation of the market. We investigate that," said Knight. "And if we feel that it needs to be further investigated we referred to FINRA or to the SEC for further work."

In 2014, Nasdaq says it flagged 766 incidents that were suspicious enough to refer to federal regulators. Officials say that regulators have moved forward on a wide range of cases that have resulted in fines and penalties for market participants.

Here are few cases involving the facility:

—A $9.5 million fine in July 2013 for brokerage and clearing firm Newedge USA for supervisory, books and records violations.

—A $1.145 million fine in May 2013 against HAP Trading for engaging in "cross product manipulation" to create false prices in securities and options.

—A $2 million fine in 2009 against Citigroup for erroneous publication of quotes, audit trail violations of trade orders and other failures.

But there's much that Nasdaq can't do from its market watch facility, including monitor trading in so-called dark pools, those private trading venues that have become a large venue for stock sales. "Right now, it is very lightly regulated and it's subject to potential abuse," Knight said. "We think it can be improved. We think more of that trading can be handled with tighter regulation."

And Nasdaq also can't see trading on other exchanges unless they specifically request it—although officials say that the coming consolidated audit trail will give them more timely information.

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