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July 27, 2005

Options Need New Master: SEC Falls Short as Regulator

By Mark Longo

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  • Options Need New Master: SEC Falls Short as Regulator
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(Traders Magazine, July 2005) -- Regular readers of my column know that I am not a fan of the SEC. As a market maker on the CBOE, I watched in horror as the SEC sat on its hands and allowed inefficiency to run rampant throughout the options markets. As a columnist, I have repeatedly criticized the SEC's refusal to act on payment for order flow and other crucial issues facing the industry.

However, despite my lack of faith in its regulatory abilities, I've always held out hope that the SEC would one day wake up to the realities of the options industry. I assumed it would eventually understand that options are very different from equities. Unfortunately, all my hope is now gone. Like many in the options industry, I have finally decided that it is time for the SEC to get out of the business of regulating options.

I came to this opinion at the recent options industry conference. Elizabeth King, the Associate Director of the SEC's Market Regulation Division, addressed the conference. Given the widespread negative perception of the SEC within the options industry, I am always impressed when an SEC representative agrees to take the heat in front of a room full of traders. Still, her comments reinforced my conviction that the SEC lacks the ability and the will to get its hands dirty in the options markets.

King began her speech by touting the incredible growth of the options business over the past five years. While this dramatic increase in contract volume is impressive, it has brought along with it a host of problems that the SEC has repeatedly ignored. Shortly into her speech, King began to repeat the same old tired SEC party line that the SEC has maintained for half a decade.

"The Commission's approach, to date, has not been to restrict payment for order flow directly in either the equities or options markets," King said. "Instead the Commission has relied on improvements in the transparency and quality of markets-which directly benefit investors-to reduce or eliminate these practices."

Good Point

King does have a point. Technology improvements such as linkage have dramatically reduced nagging issues like trade-throughs and bad fills. Still, other problems, like payment for order flow and internalization, remain prominent. Unfortunately, instead of confronting these issues, the SEC hopes the problems fix themselves. This approach may work for ostriches, but it is a strange course for a regulatory body.