The Securities and Exchange Commission, in an effort to get more information about high-frequency trading, plans to dust off an old statute that allows it to require large traders to “self-identify” themselves. As part of the plan, the SEC will propose a rule implementing a large trader reporting system for non-broker-dealers.
This new effort is expected to give the SEC more visibility into the activities of some high-frequency trading firms. Currently, the SEC does not have this access to this information.
David Shillman, associate director of the SEC’s Division of Trading and Markets, said the SEC can use its authority under Section 13(h) of the Securities Exchange Act to force large trading firms, including hedge funds and proprietary trading shops that are not broker-dealers, to file a form with the SEC and use an identification number when they trade. That would allow the SEC to gather information about their executions and help determine what impact, if any, they may be having on the marketplace.
Shillman said SEC Chairman Mary Schapiro has asked the Commission staff to develop a rule proposal to implement a large trader reporting system. The SEC, he said, will define what constitutes a large trader. Shillman spoke with reporters at the FIX Protocol Ltd. conference about technology and trading in New York on Wednesday.
“We need to get better baseline information about who the high-frequency traders are and what they’re doing,” Shillman said. He noted that high-frequency trading has grown significantly in recent years. “It has become such a dominant part of the market that now may be the time to revisit exercising our authority under Section 13(h),” he said.
“Among other things, the Commission has authority to require all large traders to self-identify and to use a large trader identifier when they trade,” he said.
Senators Charles Schumer, D-N.Y., and Ted Kaufman, D-Del., have argued in recent months that the SEC should better understand the impact high-frequency trading has on the markets. Kaufman has prodded the SEC to focus on whether high-frequency traders are harming the markets and the interests of long-term investors. Schumer has focused on potential unfair differences in access to orders and speed that various market participants, including high-frequency traders, have.
At a Securities Industry and Financial Markets Association conference last week, SEC Chairman Mary Schapiro announced that the Commission planned to propose a rule concerning high-frequency trading firms. That proposal, she said, “would shed greater light on the activities of high-frequency traders.” Although she did not provide specifics at the time, that proposal refers to the implementation of a large trader reporting system.
Schapiro said high-frequency firms helped create the current marketplace of high-speed latency-focused trading. “Compared to a few years ago, the current volume of orders and trades, and the speed of order routing and trading, are almost unimaginable,” she said. “The high-frequency traders largely responsible for these developments now likely represent more than 50 percent of trading volume.”
Schapiro said the SEC needs a “deeper understanding” of the activities of these firms and the “potential impact on our markets and investors of so many transactions occurring so quickly.” She also said the SEC needs to consider “whether there are additional legislative authorities needed to address new types of market professionals whose activities may not be sufficiently regulated.”
That additional legislative authority, Shillman said, could provide the SEC “with more direct oversight of unregulated high-frequency traders.” That oversight could allow the Commission to more effectively probe the trading strategies of firms and propose rules to address activities that are considered problematic, he said.
The authority to establish a large trader reporting system hails from the Market Reform Act of 1990, which Congress adopted in the wake of the 1987 market crash. The set of initiatives in that legislation was conceived to address the “causes of precipitous market declines,” according to the SEC’s 1991 annual report. Those initiatives also authorized the SEC to collect financial information on broker-dealer holding companies for risk assessment purposes, among other things.
Earlier, in 1989, SEC Chairman David Ruder said in a speech: “The sheer magnitude of this trading, both absolute and in relation to total market volume and value, dramatically demonstrates the need for the Commission and the [self-regulatory organizations] to have timely access to large trader information.” The trading he was referring to was portfolio trading. Ruder went on to say that the information being sought “is essential to the Commission’s ability to promote market stability.”
The SEC in 1991 proposed Rule 13h-1, which sought to establish a large trader reporting system. The proposed rule required large traders to file a form with the SEC and receive a large trader identification number. That number would have to be used by all broker-dealers effecting trades for that firm.
The large trader reporting system never got off the ground. Foreign banks resisted the rule because of confidentiality laws in their home countries, and in 2000 the SEC instead proposed Rule 17a-25. That rule requires brokers to electronically send the SEC information about “customer and proprietary securities trading,” when the Commission requests that information. The rule, adopted in 2001, enhanced the Electronic Blue Sheet system, which enables the SEC to get transaction and related information from brokers. The EBS system got its name from the blue paper that the SEC’s information requests had previously been printed on.
Richard Ketchum, CEO of the Financial Industry Regulatory Authority, which oversees nearly 4,800 brokerage firms, also thinks regulators need more data about high-frequency trading firms. “We need more information on the entities that move markets, who are often not broker-dealers–the high-frequency traders and hedge funds that are not registered,” he said in a speech last week about market surveillance and other topics.
“Right now, we are looking through a translucent veil, and only seeing the registered firms, and that gives us an incomplete–if not inaccurate–picture of the markets,” he said. FINRA is the primary regulator of broker-dealers and is making a pitch to conduct consolidated market surveillance across market centers. Ketchum noted that market surveillance is made more difficult by the ability of firms to move order flow from one market center to another “on a second-by-second basis.”