It Is Time For The SEC/NYSE To Respond To The NASDAQ's SLP Clarification Requests

Tyler Durden's picture

Now that Goldman and the NYSE's Supplemental Liquidity Provider program have finally attracted a critical mass of necessary (and hopefully sufficient) public attention, Zero Hedge would like to readdress an overlooked complaint in which none other than the NASDAQ Stock Market LLC vociferously blasts the NYSE, the SLP program, and some of the underlying assumptions. Zero Hedge has discussed this issue extensively in the past, yet neither the SEC nor the NYSE (essentially, FINRA) seem to have ever addressed any of the NASDAQ's concerns. Zero Hedge believes the time has come for the later two regulatory organizations to provide some feedback to NASDAQ's concerns.

To summarize the concerns highlighted previously, as part of the NYSE's public solicitation for comments when launching the SLP program, only the NASDAQ provided its perspectives on this program. Keep in mind, one would have to be a very aggressive anti-conspiratorial vigilante to accuse the NASDAQ of being an enterprise which sees patterns where others don't (or assume impossible).

The key objections from the Nasdaq are presented below, and the entire paper is provided for our readers' convenience (highlights and italics added).

Taken together, the SLP Proposals provide NYSE with the unparalleled ability to burden competition for order flow and executions without explaining why such ability is necessary or even prudent. For example, the SLP Creation Proposal limits SLPs to firms that engage in proprietary trading, excluding NES and others that operate on an agency basis either to comply [*6] with Regulation NMS (in the case of NES) or by choice. NYSE fails to explain why this limitation is necessary or prudent. As stated earlier, NASDAQ has often been the largest liquidity provider to the NYSE and yet would be disqualified from serving as an SLP under the SLP Proposals. NYSE fails to explain why proprietary liquidity is more valuable than agency liquidity, or why proprietary liquidity should be favored over agency liquidity. NYSE claims that the proposal is designed to prompt liquidity provision but it simultaneously disqualifies large liquidity providers.

In NASDAQ's view, these irregularities reveal that NYSE's true motivation for the SLP Proposals is to discriminate among its members and to burden some members' ability to compete with NYSE. NYSE's failure to explain adequately either the operation or the rationale for its proposed rule is evidence that NYSE's stated basis for the proposal is a pretext. NYSE's proposals are a naked attempt to disadvantage one group of members -- those that compete with NYSE -- to benefit another class of members -- those that do not compete with NYSE...

Perhaps most surprising is the NYSE's aggressive attempt to implement these proposals on an immediately- effective basis. In doing so, the NYSE prompted the Commission to act inconsistently with past practice, inconsistently with its Rule Streamlining Guidance issued in July of 2008 n5, and inconsistently with its obligation to ensure that self-regulatory organizations comply with their obligations under Section 6 of the Securities and Exchange Act [*8] of 1934. NASDAQ, as an active proponent of the Rule Streamlining Guidance, is concerned that the NYSE will undermine that streamlining effort by attempting to leverage the Guidance in an inappropriate manner.

To support immediate effectiveness, the NYSE SLP Creation Proposal cleverly collects numerous past rule proposals that touch tangentially upon the topic of market makers and fees. None of the cited proposals is directly appurtenant to NYSE's SLP Proposals. For example, the Commission has not previously approved the creation of a new class of market participants on an immediately effective basis, and none of the cited proposals stands for that proposition. The Commission [*9] has not approved a new process for discriminating between members without requiring member representation or other governance protection for members. The NYSE attempted to overwhelm this weakness through sheer numbers of citations.

The NYSE has demonstrated there are many latent questions regarding its closeness with the main and only SLP provider, Goldman Sachs. In order to faciltitate the spirit of transparency and deobfuscation, Zero Hedge kindly requests that Mr. Ray Pellecchia answer these questions which not only the NASDAQ but Zero Hedge and its readers find of great interest.

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Anonymous's picture

"However, the New York Stock Exchange said on Monday there was no connection between the alleged security breach and an error that dropped Goldman from a trading report the NYSE issued last week."

In the original story before it was updated the NYSE took responsibility for Goldman being dropped from the list but gave no explanation as to why.

sunbringer's picture

"The case could shed light on the workings of intricate trading systems developed by Goldman. It also raises questions about the security of lucrative Wall Street proprietary trading operations."


Anonymous's picture

I aM jAcks solE LuCidity providEr

percyklein's picture

This amends a comment I made yesterday.

Let me put a couple of questions to you about "micro-trading" by Goldman and other dealers (which for convenience I will refer to below collectively simply as the "Dealers") and about the NYSE's SLP program.  First, I must set the stage, as it were.

The Dealers, obviously,  effect their  "micro-trades" for their own accounts, as principal, by means  of software and systems they own and have  developed for this purpose -- the very programs that, in Goldman's case, gave rise to theft of the computer code that is the subject of others threads here and by means of which it is alleged  that Goldman can manipulate markets for profit and, even if that is not the case, can generate amazing trading profits on a regular basis.  Further, the Dealers  seem to have arranged for creation of the SLP dealer-only trading program by the NYSE, to which members can gain entry only if they trade in the program exclusively for their own accounts and not as agents for customers, attracting the ire of NASDAQ, which seems to want its broker-dealer affiliate to get in on the program.  (The "market maker" exemption from Section 11(a) exempts market makers from that section's prohibition against trading by members for their own accounts or the accounts of affiliates ahead of orders for the accounts of other market participants, such as ordinary customers, their own or the customers of other members.)

Note that investment advisers registered as such under the Investment Advisers Act have a fiduciary duty to their advisory clients to trade for the benefit of those clients ahead of trading for their own (that is, the adviser's)accounts and to refrain from trading for themselves in a way that might take unfair advantage of or disadvantage these clients.  It seems relevant here that the Obama Administration has told Congress in its White Paper that the law should be changed to impose fiduciary duties on all broker-dealers in their dealings with their customers, for whom they are supposed to act as loyal agents -- but the Advisers Act already does this in the case of broker-dealers that are registered now as investment advisers.

Now for the questions:

Are not some of these Dealers, and here I include Goldman in particular, registered as investment advisers under the Advisers Act?  If so, are they not already obligated, as fiduciaries to their advisory clients, to make their "micro-trading" programs available to and use those programs for the benefit of those clients  where they have investment discretion rather than using them exclusively for themselves as propritary traders?  Do they?  If not, why have they not been investigated and sanctioned for failure to do so?

There can be quibbles about whether exercise of discretion in this manner by Dealers that are investment advisers with discretion to trade their clients' assets would be consistent with the investment  "mandates" of those clients. One would think, though, as a common law fiduciary matter, that a Dealer investment manager that knows its advisory clients could or would be advantaged by altering their instuctions to the Dealer as to managment of their accounts in a way that would enable the Dealer to use its profitable "micro-trading" program for the benefit of those clients has a duty to bring that to the attention of existing and prospective advisory clients. 

 It also might be the case that the Dealers have sought and obtained explicit waivers from their advisory clients of any right to insist that trading for their accounts be conducted in the same manner as proprietary trading by those Dealers for their own accounts. One doubts this, however, not only because it would so clearly put the interests of the Dealer at odds with the interests of the advisory clients -- it might be asked who in his right mind would hire such an investment manager -- but also because there would be very serious questions whether such a waiver would be valid under the  federal securities laws.  

In the case of the SLP program, the limitation on trading by members as agents for their customers seems intended to free Dealers who are investment advisers from their obligation to use their trading abilities and resources primarily if not exclusively for the benefit of their advisory clients by prohibiting them from doing so.  One would think, though, that this would not excuse the Dealers from their obligations under the Advisers Act and relevant state laws to refrain from trading for their own accounts in their SLP capacities that does or could disadvantage their advisory clients.  After all, nothing prevents the Dealers from confining their trading activities to acting as principal only rather than also assuming, as they have, obligations to advisory clients as investment advisers. 

It should be noted that in what now can only be referred to as the old days, the first seven decades after passage of the Exchange Act, specialists, the arch-type of a market maker, were not associated with and never performed the functions of an investment adviser along side of their functions as specialists. (In the very old days, prior to enactment of that statute, they could exercise discretion in buying and selling for customers. This practice, however, was banned by the Exchange Act becuase of its obvious unfairness to other market particiants since then the specialist was at at the heart of all trading on exchanges, and the trading of listed stocks occurred almost exclusively on exchanges because that was where price discovery took place, now only a quaint notion given global electronic OTC trading.) 

Even putting aside how, as a legal matter, Dealers who are investment advisers with discretion to invest their clients' assets can get away with failure to use their "micro-trading" techniques and their powerful positions in the SLP program on behalf of their advisory clients instead of only for their own accounts, how do the Dealers ensure that they do not trade in the SLP program or by means of "micro-trading" a manner that takes advantage of or disadvantages those clients?  Shouldn't the SEC be investigating at least this and, if the Dealers cannot demonstrate that they have taken appropriated measures to ensure that this never does or can happen, should they not be sanctioned for failure to do so?