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July 6, 2009

Big Banks at Odds with Regulators Over Sponsored Access

By Peter Chapman

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  • Big Banks at Odds with Regulators Over Sponsored Access
  • Page 2

Representatives from the bulge bracket squared off against regulators in late May over calls for tightening controls on the banks' sponsored-access businesses.

Lawyers from Morgan Stanley, Bank of America/Merrill Lynch and Goldman Sachs, speaking at a conference sponsored by the Securities Industry and Financial Markets Association, voiced their discontent with new rules proposed by Nasdaq that would saddle their firms with new responsibilities toward some of their direct-access customers.

Officials from the Financial Industry Regulatory Authority and NYSE Regulation were on hand to defend the idea of new rules.

At issue is the banks' business of permitting certain customers to directly access exchanges and ECNs with little or no oversight of each and every order. The regulators, including the Securities and Exchange Commission, want to see the broker-dealers scrutinize the trades. The banks argue it will kill a business that thrives on secrecy.

"Pre-trade limits that you impose on sponsored access that does not flow through your pipes undermines that product," Lauren Mullen, an attorney in the equities department at Bank of America/Merrill Lynch, told conference-goers.

Tom Gira

Annette Kelton, a Goldman Sachs attorney, complained: "The Nasdaq proposal seemed to be placing a strict liability standard on broker-dealers. That is changing the entire standard that we are subject to which is reasonable detection and prevention."

Sponsored access generally refers to the practice of broker-dealers allowing such electronic trading shops as hedge funds and broker-dealers to interact with the markets under their names but without their physical accompaniment.

There are three types: (1) traditional direct market access, where the customer uses the software and order-routing capabilities of the broker-dealer (2) access where the trading house uses the software and order-routing capabilities of a vendor; and (3) access where the trading house uses its own software and order-routing capabilities.

It is the latter two methods that have caused the most alarm. Regulators and exchange executives are worried that orders may not be vetted for financial and compliance risks if they are not passing through the brokers' pipes. Some market players are calling for a complete ban on the third type of sponsored access, disparagingly calling it "naked access."

Tom Gira, executive vice president in FINRA's market regulation department, explained the problem to SIFMA conference-goers: "We have had instances where firms have called and wanted to bust trades. They'll say the customer made a mistake. But they can't tell you the mistake. That's a scary place to be when markets are moving and it is clear there is no control over incoming orders."