SEC Pokes Hole in Argument Its Too Slow to Get Grip on Markets

(Bloomberg) — Bit by bit, the U.S. Securities and Exchange Commission is answering critics who say its asleep at the switch when it comes to high-frequency trading.

The agency announced another record fine Thursday against UBS Group AG, saying the bank favored professional market makers when it violated rules designed to ensure stock trades are executed fairly.

UBSs penalty comes just days after Bats Global Markets Inc. was ordered to pay $14 million for disclosure violations at its Direct Edge exchanges, capping one of the busiest weeks yet for SEC investigators charged with rooting out inequities in Americas computer-accelerated stock market.

These cases show that we can handle these complex investigations involving a very complicated industry, SEC Enforcement Director Andrew Ceresney told reporters yesterday.

Ceresney said the regulator will bring more cases in the coming months against dark pools, which rose to prominence as computers took over U.S. equity markets as places where large investors could trade without moving prices.

Last year, the agency fined Liquidnet Holdings Inc. $2 million for not living up to client secrecy standards. In 2011, Pipeline Trading Systems LLC agreed to pay $1 million to resolve claims it failed to provide the confidentiality and liquidity it advertised to customers.

Just this week, a person with knowledge of the matter said the SEC was considering rules that would force dark pools to comply with some of the same requirements exchanges face. Among the ideas under review is forcing dark pools to disclose the types of orders they offer, according to the person. Thats the area where UBS ran afoul of U.S. regulators, the SEC said.

Harming Markets

SEC Chair Mary Jo White, who said in June that the growth of dark trading is harmful to markets, has pledged to take on the most contentious issues facing equity markets. Earlier this week the agency announced an expert panel to advise on how to deal with issues including dark pools, high-frequency trading and conflicts of interest in the routing and execution of stock orders.

While the SEC has picked up its efforts recently, some say regulators have been slow to address market-structure issues and abuses. The UBS conduct, for instance, dates back to 2008.

For the SEC to take six years to years to deal with this situation is scandalous, said James Angel, a professor at Georgetown University in Washington who specializes in financial market structure. It hurts the SECs credibility as an agency enforcing its own rules.

Schneidermans Probe

New York Attorney General Eric Schneiderman last year took aim at the industry, stepping into one of the SECs prime areas of oversight. Schneiderman sued Barclays Plc, claiming the bank lied to customers while secretly cozying up to high-frequency trading firms. Barclays has denied the claims.

The proliferation of exchanges and dark pools has also been defended by some at the agency. Gregg Berman, the Princeton- trained physicist who runs the SECs analytics office, said last year that the desires of investors and investment managers entails an unavoidable increase in the complexity of our markets.

UBS was cited for technical violations of Regulation NMS, the SEC regulation that took effect in 2007 to ensure that anyone trading shares on U.S. markets gets the best price available when placing an order.

Electronic order types for trading shares have become a focus in the debate around high-frequency trading. In the past human market makers acted as traffic cops matching requests to buy and sell stocks on exchange floors. Now the process is managed by software that critics say is poorly understood by anyone but professional traders.

Record Fine

In ordering UBS to pay $14.4 million, including a $12 million fine that exceeds all prior penalties against an alternative trading system, the SEC flagged a series of violations from 2008 to 2012. It said UBS let customers submit orders at prices denominated in increments smaller than a penny, something SEC rules prohibit because it can be used to get a better place in line when buying or selling stock.

The ability to trade in sub-penny increments also wasnt widely disclosed to UBS customers, and was instead pitched secretly to market makers including high-frequency traders, according to the SEC.

UBS, which runs the second-largest U.S. dark pool, didnt admit to or deny the SECs findings. UBS said in a statement that the issues leading to the SECs sanctions were fixed in mid-2012, and the firm has updated and improved its supervisory procedures.


One of the UBS order types, called PrimaryPegPlus, let users specify an intent to buy or sell stock above or below prevailing market prices. According to the order, UBS only told a subset of subscribers that the order was available, almost all of them market makers or high-frequency traders.

The formula for determining the price for a PPP order also included a percentage of the spread and almost always yielded a sub-penny amount, the SEC said. That made PPP order prices nearly always appear in illegal, sub-penny increments, according to the order.

The other, known as Whole Penny Offset, let users enter orders one penny above or below the midpoint between the national best bid or offer for a given stock. Between January 2009 and June 2010, the protocol resulted in executions for about 1.5 million shares, the SEC said.

UBS also failed to live up to the secrecy pledges of the dark pool, giving 103 employees who shouldnt have had access the ability to see clients confidential trading data, the SEC said.