SEC Intends To Prohibit Naked Access, Seeks Public Comment

First flash, now naked access. While we are certain those whole livelihood depends on scalping and manipulating markets and finding loopholes from regulation will scream bloody murder (look at the industry response to suggestions that HFT is "evil") will provide some very vocal public comments, at least the SEC implicitly acknowledges that naked access is not quite the boon to investors that Goldman et al would like to make it seem.

It should come as no surprise that Zero Hedge has long been warning against the dangers of sponsored/direct/naked access. Some broad background on the topic can be found here and here.

For once we applaud the SEC in this endeavor. Of course, once the SEC ends the public comment solicitation period with "no action", or a ruling that does nothing at all to change the actual naked access process, we will resume our daily calls for Mary Schapiro's immediate resignation.

The following is the text of an SEC fact sheet:

Overview:

The Securities and Exchange Commission will consider proposing a rule that would effectively prohibit broker-dealers from providing customers with "unfiltered" or "naked" access to an exchange or alternative trading system (ATS).

It would also require brokers with market access, including those that sponsor customers' access to an exchange, to put in place risk management controls and supervisory procedures.  Among other things, the procedures would help prevent erroneous orders, ensure compliance with regulatory requirements, and enforce pre-set credit or capital thresholds.

Background:

Market Access by Broker-Dealers

Broker-dealers are required to comply with the rules of the exchanges to which they have access.   Using their special pass,' known as the market participant identifier or MPID, they can electronically
access an exchange or ATS and place an order for a customer.

Broker-dealers are specially regulated with respect to their access on an exchange or ATS because they are subject to the federal securities laws as well as the rules of the self-regulatory organizations that regulate their operation.

Customers Placing Orders Themselves

Today, most orders are routed for execution in milliseconds through high-speed, high-volume, automated algorithmic trading.  High-frequency trading alone has been estimated to account for more than 60 percent of the U.S. equities market volume.  As a result, some sophisticated
customers  particularly institutions  have begun using technological tools to place orders and execute high-speed trades themselves.  They do so by essentially bypassing their broker-dealer, who provides the customer with the MPID.

When the customer is provided with access to an exchange or ATS using the broker-dealer's MPID, the arrangement is known as "direct market access" or "sponsored access."

In some of these arrangements, the customer is able to place an order that flows directly into the markets without first passing through the broker-dealer's systems and without being pre-screened by the broker-dealer in any manner.  This type of direct market access arrangement is known as "unfiltered" access and "naked" access.

A recent report has estimated that naked access accounts for 38 percent of the daily volume for equities traded in the U.S. markets.

Regardless of the type of market access, the broker-dealer who provides the access is legally responsible for all trading activity that occurs under the MPID.

The Potential Concerns Associated with Sponsored Access:

There have already been signals of the dangers posed by not maintaining effective risk management controls for sponsored access.  For example, it was reported that, on September 30, 2008, trading in a listed stock became extremely volatile toward the end of the day, dropping 93% in value at one point, due to an influx of erroneous orders onto an exchange from a single market participant operating through a sponsored access arrangement.  As a result, numerous trades had to be canceled and the stock's closing price had to be adjusted.

Through sponsored access, especially "unfiltered" or "naked" sponsored access arrangements, there is the potential that financial, regulatory and other risks associated with the placement of orders are not being appropriately managed.  In particular, there is an increased likelihood that customers will:

* enter erroneous orders as a result of computer malfunction or human error,
   
* fail to comply with various regulatory requirements, or

* breach a credit or capital limit.

Requirements Under the Proposal:

The proposed rule would require broker-dealers, who are members of an exchange or subscribe to an ATS, to implement certain risk management controls and supervisory procedures to manage the various risks.  These controls and supervisory procedures would effectively eliminate "unfiltered" or "naked" sponsored access.  Under the proposed rule, a broker-dealer must establish, document and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory and other risks related to its market access, including access on behalf of sponsored customers.  In association with this requirement broker-dealers must:

* create financial risk management controls reasonably designed to prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous;

* create regulatory risk management controls reasonably designed to ensure compliance with all regulatory requirements applicable in connection with market access;

* have financial and regulatory risk management controls applied automatically on a pre-trade basis before orders route to an exchange or ATS;

* maintain risk management controls and supervisory procedures under the direct and exclusive control of the broker-dealer with market access; and

* establish, document and maintain a system for regularly reviewing the effectiveness of its risk management controls and for promptly addressing any issues.

What's next?

The proposal seeks public comment and data on a broad range of issues relating to market access, including the costs and benefits associated with the proposal.  After careful review of comments, the Commission will consider what further action to take on the proposal.

Comments

[FreakuentFlyer]

what about buying low and selling high - is that still permitted?

[Anonymous]

Only buying will be permitted in the future. If you sell anything at a profit, you'll have to turn those profits over to the SEIU. If there are losses, you can keep those.

[Missing_Link]

This sounds like a big step in the right direction.  Hopefully the rules on risk management controls aren't too open to interpretation.

[Anonymous]

Do you work for a broker-dealer?

[peterpeter]

Risk controls should be placed at the trading venues.

Eliminating naked access will simply produce an influx of applications to become broker dealers as many HFT shops will be happy to pay for the lawyers required to sort through the following:

http://www.sec.gov/divisions/marketreg/bdguide.htm

[Anonymous]

What about the broker-dealer themselves? What rules to prevent manipulating the client order prices and tweaking the time-ordering and various other forms of manipulations?

Where is the full set of checks and balances?

If you take a wider view of many of these recent (and not so recent) developments of the things that are happening, you will see strange biases against the retail traders. Well what else can you expect when the casino writes its own rules to play. You are not supposed to win in the long run but merely exist your useful life as a liquidity provider in the ponzi casino.

DMA is a too powerful a tool to be given to the unwashed class. Let them have cake...

[jedwards]

I can't remember who said this, but we do not need more efficient financial markets.  Sure it makes things more convenient for bankers, but it also makes the system TIGHTLY COUPLED, which means that it's easier for the entire thing to collapse.

We do not need fucking faster trading at this point.  We need less things that can jeopardize the system.  Fuck I really hate these greedy selfish motherfuckers.

[Anonymous]

This is the sec web site. On the left portion of the page is the area where they are seeking public comment.
http://www.sec.gov/

[Anonymous]

Mark Cuban ages ago said something like this: Holding 10000 stocks in a company does not really gives you a "fractional ownership". The whole concept of fractional ownership is bogus, as is the notional relationship of company performance and stock prices - when there is no significant dividend payout. Stock valuation is no different than putting a price on a piece of painting or a bunch of tulips. Whether you are a follower of Graham or Murphy does not make a difference. Its all about a story and the number of people who bets for the story versus against the story. The story can be about a PE ratio or can be about a support/resistance level. Pricing in a double auction market is just crowd psychology. As simple as that.

I completely agree with Adair Turner when he says that financial markets do not serve any useful economic purpose. The best thing for the society at this point is to shut down each one of these casinos.

Let the corporates raise money for business via the debt market with very clear terms/consequences for repayment/non-payment/rollover. The way things were before the rouge Frenchman invented the stock exchange.

Now, imagine what could be accomplished if so much of capital and the thousands of PhDs were to work on the real problems of this planet?

An old man (Project Venus?) once said, the real price of most essential commodities should be zero because even with today's science we could produce/recycle enough of everything so that there is enough for everyone. But then unless there is scarcity there will be no "economics" and the instrument called "money" will be useless. There won't be a sustained power pyramid and elites won't exist. So we need all these layer after layer of complicated "financial" innovations.

So, how many of you think that all stock exchanges should be closed?

I know you will all agree with me but still want the casino to remain open.

See the point? We humans (like all animals) are not capable of going beyond the immediate self and immediate timeframe ... even if that means we leave a mess for our kids.

So, till we are able to get over this addiction, let us try to invent ways to game the gamesters. I am told supercomputers cost only 4000$ these days.

[the grateful un...]

since the government already uses margin requirements to manipulate the markets, we should suppose this gives them more power, and the individual less. speed of access certainly allows brokers like Goldman to extract tribute from the retail investor. Before all this happened the retail investor had to contend with market makers, bid/ask spreads, slippage, bad fills, orders placed on third and fourth tier markets, where they could be easily picked off. That is why the day trader went extinct, and some of them went postal first. Now we know Goldman is using its position as one arm of the Treasury/Fed liquidity operation to frontrun the retail suckers. Bill Gross made the obvious statement, figure out what the government is doing, and then do it? (in this case just don't get caught)

[Anonymous]

NBBO= National BEST Bid Offer System
Not
National BYPASS Bid Offer System

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