SEC seeks ban on unsupervised access to stock market
- SEC Seeks Ban on Unsupervised Access to Stock Market Bloomberg, January 13, 2010
The Securities and Exchange Commission voted to propose banning brokers from providing clients with unsupervised access to stock exchanges, a practice that accounts for about two of every five shares that trade in the U.S.
Chairman Mary Schapiro said so-called naked sponsored access, in which a customer bypasses the pre-trade controls of his broker and accesses exchanges directly, may expose the market and firms that offer the service to too much risk.
“We are concerned that order-entry errors in this setting could suddenly and significantly make a broker-dealer or other market participants financially vulnerable within mere minutes or seconds,” Schapiro said at a hearing in Washington today.
Commissioners met today to begin formulating the next round of stock market regulation, focusing on strategies used by professional investors, such as sponsored access, and “dark pool” trading venues. The agency voted 5-0 to approve the market-access proposal.
Sponsored access represents about half of U.S. equities trading, with unfiltered access accounting for 38 percent, Aite Group LLC, a financial services research firm in Boston, said in a December report. The SEC has been under pressure from Senator Ted Kaufman of Delaware and others to address concerns that so- called high-frequency firms could disrupt the market with trading that isn’t properly monitored through tactics such as unfiltered market access.
Jeopardizing a Firm
Accidental orders and those that don’t comply with regulations could enter the market, jeopardizing the firm getting sponsored access or its executing and clearing brokers, according to Schapiro. Sponsored access refers to arrangements where a broker gives customers its identification number so they can trade on exchanges or other venues.
In addition to the potential for erroneous trades, naked sponsored access may allow deliberate fraud and illegal trading such as improper short selling to go unmonitored, according to the SEC.
“Such ‘unfiltered’ arrangements occur mainly to give a customer -- often a high-frequency trader -- a fraction-of-a- second advantage in the high-speed transactional world that exists today,” Schapiro said.
The SEC’s proposal would require brokers to establish pre- trade risk controls and supervisory procedures for customers that now get unfiltered access. These include safeguards to reduce the chances of erroneous orders due to computer malfunctions or human error, orders that potentially breach a firm’s credit or capital limit, and those that fail to comply with regulatory requirements.
Robert W. Cook, the new director of the SEC’s division of trading and markets, said the SEC has “increased concerns about the quality of broker-dealer risk controls in all market access arrangements,” particularly when there is “little or no substantive intermediation by the broker-dealer providing that access.” Risk checks “must be under the direct and exclusive control of the broker-dealer” and cannot be delegated to the firm getting sponsored access to exchanges, he said.
Many of the biggest brokers don’t allow unfiltered access and have been critical of the practice. New York-based Goldman Sachs Group Inc. and Morgan Stanley permit customers to use sponsored access as long as their orders are checked for risk.
The Aite report said the industry average for typical pre- trade risk checks is about 125 microseconds. A microsecond is a millionth of a second.
Liquidity, Lower Fees
In addition to sponsored access, the SEC is seeking input from securities professionals on strategies used by so-called high-frequency traders after lawmakers including Kaufman, a Democrat, questioned whether the practice is benefiting Wall Street at the expense of individual investors. Proponents of the technique say it has lowered fees, boosted liquidity and increased volume.
The SEC is reviewing “what effect this massive transformation in which high-frequency trading dominates volume may be having on individual and fundamentally driven investors,” and whether it disadvantages them,” said Justin Schack, director of market structure analysis at Rosenblatt Securities Inc. in New York.
The SEC asked for guidance on whether to impose new rules on high-frequency trades, whether “highly automated, high- speed” trades hurt investors and what metrics regulators should use to determine the effects of new trading strategies on long- term investors, the agency said in a statement today.
The SEC also asked about co-location, where traders and securities firms place servers close to the main computers of exchanges in data centers to shave time off their orders. The agency wants to know whether co-location gives traders unfair advantages and whether firms using this service should face regulations.
SEC commissioners voted 5-0 today to publish a so-called concept release that will solicit feedback from traders, brokerages and stock exchanges. The SEC will seek comments for 90 days before deciding whether to propose any regulations.
- FPL’s New Risk Guidelines Target Algo, DMA and Sponsored Access A-Team Group, January 24, 2011