SEC Prepares Own Rule Proposal on Sponsored Access

Traders Magazine Online News, October 27, 2009

Nina Mehta

The Securities and Exchange Commission is likely to get tougher with sponsored access arrangements that allow firms to access the markets directly.

SEC Chairman Mary Schapiro said she has asked her staff to develop a sponsored access rule proposal. This comes even as the SEC has been working with Nasdaq OMX Group to devise a broader rule concerning direct access to its market for nearly a year.

Any rule proposal approved for Nasdaq would be copied by other exchanges and implemented in their markets to prevent different treatment of direct access arrangements by different market centers. Nasdaq submitted a 54-page amendment to its rule proposal on Oct. 19.

Schapiro stressed the Commission's urgency in coming up with a sponsored access proposal that would be rigorous and effective enough to deal with high-frequency trading firms and others using sponsored access arrangements to reach the markets. "I recognize some markets have been seeking to address this issue, but I also worry that competitive pressures could delay an effective solution--one that would apply across all markets to assure a level playing field for all investors," Schapiro said. She spoke today before several hundred industry professionals at the Securities Industry and Financial Markets Association's annual conference, in New York.

Nasdaq last January proposed a rule concerning the methods used by both brokers and non-brokers to gain access to the markets through a broker-dealer's membership. Many market participants use direct market access through brokers to reach exchanges and electronic communication networks. However, a segment of those getting "sponsored access" has elicited concerns in the industry.

While sponsored access refers to firms accessing exchanges directly, typically through their own pipes and technology, "unfiltered" access is sponsored access that omits the pre-trade risk checks that would otherwise be implemented on that flow. This type of unfiltered access is used to shave off microseconds in sending orders to an exchange's servers.

Schapiro's comments could signal a new or altered approach to sponsored access, Richard Ketchum, CEO of the Financial Industry Regulatory Authority, told Traders Magazine. The gist of Schapiro's comments, he said, is that "this may need to be a Commission rule," rather than one proposed by the exchanges.

It is also possible that the SEC is upping the pressure on Nasdaq and other exchanges to produce a rule proposal that deals vigorously with the risk issues on the SEC's radar. Alternately, the SEC could impose a sponsored access rule on top of any rule approved for Nasdaq and other market centers.

Nasdaq said it is working with the SEC on its rule proposal. "Nasdaq OMX is the only market that has proposed rules regarding the regulation of sponsored access, and those rules are pending before the SEC," a Nasdaq spokesman told Traders Magazine. "We believe regulation is needed and that rules in this area can only be effective if they are applied consistently across markets."

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