Speech by SEC Chairman:
Statement at SEC Open Meeting — Market Access
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
January 13, 2010
Good Morning. This is an open meeting of the U.S. Securities and Exchange Commission on January 13, 2010.
Today we are taking another step in our effort to restore confidence and ensure our markets are fair and efficient. As you know, toward the end of last year we proposed rules to ban the flashing of marketable orders and to increase the transparency of dark pools.
Today, we continue our efforts.
First, we will consider whether to propose a rule that would effectively prohibit broker-dealers from providing customers with “unfiltered” access to an exchange or alternative trading system (ATS). The rule would also require other measures to reduce market access risks.
Later, we will consider whether to seek comment on a host of questions concerning the structure of our markets.
Market Access Proposal
The first proposal we are considering seeks to minimize the risks that broker-dealers incur when they access the market on behalf of their customers or themselves.
In some circumstances, broker-dealers turn over to their customer a special “pass” to access the markets — known as the market participant identifier. In turn, the customer then gains access to the applicable exchange or ATS. This is known as sponsored access or direct access.
To take it one step further, under some access arrangements, the customer simply bypasses the broker-dealer entirely — and thus, the broker dealer’s risk management controls. Through this type of arrangement, known as “unfiltered” or “naked” access, the customer places an order that flows directly into the markets. The order does not first go through the broker-dealer’s systems -- and is not subject to any pre-screening by the broker-dealer. 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.
A recent report has estimated that naked access accounts for 38 percent of the daily volume for equities traded in the U.S. markets.
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.
Last fall, I likened unfiltered access to giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied. Today’s proposal would, in short, require that if a broker-dealer is going to loan his keys, he not only must remain in the car, but he must also see to it that the person driving observes the rules before the car is ever put into drive.
Already, there have been signals of the potential dangers posed by giving customers access to the markets without effective controls. In September 2008, for example, it was reported that there was an influx of erroneous orders for a listed stock by a single market participant. As a result, the stock dropped in value more than 90%, numerous trades had to be canceled, and the stock’s closing price had to be adjusted.
At the Commission, we must be vigilant in identifying and addressing emerging risks to investors, broker-dealers, and the integrity of our markets.
Today’s rule would require broker-dealers with market access or that provide market access to others, to put in place effective pre-trade risk management controls and supervisory procedures. These controls would effectively prohibit “unfiltered” access. The controls would also help to ensure greater supervision of those customers who are otherwise given access to an exchange or ATS. More generally, the proposed rule would require brokers to implement effective financial and regulatory risk management controls and supervisory procedures on a market-wide basis.
Such controls would reduce the chances of:
- an erroneous order due to a computer malfunction or human error;
- a potential breach of a credit or capital limit, and
- a failure to comply with regulatory requirements.
These controls should help to reduce risks to broker-dealers and the markets as a whole and would help strengthen the vital gatekeeper functions that broker-dealers have historically played in maintaining the integrity of the markets.
The Commission is committed to its core mission of protecting investors and to maintaining the confidence of investors that the markets are working as intended and working for their benefit. To do otherwise, would risk sacrificing the stability and fairness of the markets.
I would like to thank the staff of the Division of Trading and Markets for their work on this matter, specifically Director Robert Cook, Deputy Director James Brigagliano, David Shillman, John Roeser, Marc McKayle, Theodore Venuti, and Daniel Gien. I would also like to thank our colleagues in the Office of the General Counsel, specifically David Becker, Meridith Mitchell, and Janice Mitnick, as well as in the Division of Risk, Strategy, and Financial Innovation, Henry Hu, Jim Overdahl, Amy Edwards, Cecilia Caglio, and Adam Glass, for their contributions and collaborative efforts. Finally, I would like to thank the other Commissioners and all of our counsels for their work and comments on the proposed rule.
Now I'll turn the meeting over to Robert Cook, Director of the Division of Trading and Markets, to hear more about the Division’s recommendation. Welcome Robert — this is your first Commission meeting and we are thrilled you are here.