Brokers Call for 'Naked' Exemption
Traders Magazine Online News, February 19, 2010
Two of the biggest sponsors of unfiltered access into the country's exchanges are gearing up to fight a Securities and Exchange Commission proposal intended to kill the business.
Jeff Bell, Wedbush Securities
Brokerage and clearing firms Wedbush Securities and Penson Financial Services say a proposed rule requiring them to implement pre-trade risk checks on their orders should not apply to them, because their clients already perform such checks.
"I think the idea of having a broker-dealer do it twice is kind of a problem," said Jeff Bell, executive vice president of Wedbush's clearing and technology group. "Regardless if there's sponsorship or not, a broker-dealer is responsible for making sure that they meet all of these various requirements."
In January, the SEC proposed regulations targeting the practice of sponsored access. Sponsored access refers to arrangements broker-dealers construct that let select market participants send orders directly to exchanges with minimal latency and without passing through the broker's infrastructure. By comparison, direct-market-access orders pass through the sponsoring broker's infrastructure.
The SEC has honed in on pre-trade risk checks as the differentiating factor. Orders that reach an exchange without pre-trade risk checks do so through unfiltered, or "naked," sponsored access.
Pre-trade checks, the SEC argued, "help prevent erroneous orders, ensure compliance with regulatory requirements and enforce pre-set credit or capital thresholds." The SEC said pre-trade risk checks on orders are vital to protecting the integrity of the markets. Such checks increase latency, which is inimical to all sponsored-access customers' high-frequency-trading strategies.
Wedbush and Penson object to the SEC's blanket approach to the issue and are pushing the regulator to qualify its proposal. They contend that exchange rules already require exchange member broker-dealers to check their trades before sending them out.
But if the proposal becomes a rule, the firms said they'd have to start incorporating pre-trade risk checks into their processes--an unnecessary redundancy, they argue. Both firms are angling to find a compromise during the comment period that would preserve their current sponsored-access business models.
The SEC released its proposal on sponsored access on Jan. 13, the same day it approved a Nasdaq rule on the subject. Nasdaq had been laboring for four years to set rules for sponsored access.
Both Penson and Wedbush have already been sharpening their arguments throughout the years Nasdaq has been amending its rule. In its approved version, Nasdaq requires broker-dealers who provide sponsored access to the exchange to apply pre- and post-trade financial and regulatory controls when doing so.
The SEC proposal expanded upon Nasdaq's rule. It would require broker-dealers to apply risk checks automatically on a pre-trade basis whenever it directly accesses any exchange or ATS--whether for the sponsored access or direct market access of a client's order.
The broker-dealer alone would manage these controls and could not entrust them to a customer or a third party. It also would require a broker-dealer to create a supervisory system to verify the controls' effectiveness in perpetuity.
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