Last Friday, the one-year anniversary of the flash crash, SEC Chairman Mary Schapiro told attendees at the Investment Company Institute's annual general-membership meeting that the commission is looking at further regulation of high-frequency traders and mandating standards for exchanges' automated systems to make sure that something similar doesn't happen again.
Meanwhile, when asked after her speech about 12(b)-1 reform, Ms. Schapiro said that the issue is top-of-mind.
“We need to tackle this issue, and we will look at this in tandem with [the investment adviser broker-dealer study] because there is a relationship be-tween them,” she said.
Ms. Schapiro declined to say whether the Securities and Exchange Commission will re-issue the 12(b)-1 proposal, given the more than 2,400 comment letters it has received about the issue, but she did say that the SEC will take into account various criticisms around it.
“Commentators raised some important issues for us to look at with respect to 401(k) plans and the ability to preserve options for how they pay for services: disclosure issues and a desire to create competitive pricing in a way that really benefits investors,” she said.
The SEC is keeping its focus on 12(b)-1 reform, which it expects to get back to this summer.The commission will look at it in tandem with its approach to creating a universal fiduciary standard for brokers, Ms. Schapiro said after her speech.
During the May 6, 2010, flash crash, the Dow Jones Industrial Average dropped 1,000 points, with hundreds of stocks briefly trading at close to zero before rebounding within minutes.
Even though most of those trades were canceled, the implications of that event still haunt the markets, Ms. Schapiro said.
“The significance of May 6 is greater than the investor harm caused by these wild swings in prices. It lies in the significant blow to investor confidence this volatility delivered, as well,” Ms. Schapiro said.
“Because while every investor accepts financial risk as a fact of life, they operate under the assumption that America's markets are structurally sound, that the funds you represent and the investors you advise could confidently entrust their capital to the world's most sophisticated financial markets,” she said.
The SEC is examining whether high-frequency traders should have obligations similar to market makers, given the large implications of their actions on the markets.
During the flash crash, such traders represented more than 50% of market volume and “were net aggressive sellers during the broad index price decline,” Ms. Schapiro said.
“High-frequency traders turned what was a very down day for many investors into a very profitable one for themselves by taking liquidity rather than providing it,” she said. “I think their activity that day should cause us to thoroughly examine their current role.”
Additionally, the SEC is looking at requiring exchanges to participate in the commission's automation review policies “and, as such, require market participants to meet adequate standards for the capacity, resiliency and security of their automated systems,” Ms. Schapiro said.
The SEC over the past 12 months has worked with the
Financial Industry Regulatory Authority Inc., the
Commodity Futures Trading Commission and the exchanges on rules and proposals to address the issue.
TIMELY ACCESS
In May 2010, the SEC proposed establishing a consolidated audit trail that would allow regulators timely access to orders on the national market system. The SEC is reviewing comments on that proposal, Ms. Schapiro said.
Last June, the SEC began a pilot circuit breaker program that was applied to stocks in the S&P 500 and now includes all stocks in the Russell 100 Index as well as 300 exchange-traded funds.
In September, the SEC approved exchange and Finra rules to allow for the cancelation of “clearly erroneous” trades.
And in November, the SEC approved rules that enhance the quotation standards for market makers to get rid of stub quotes, which represented a large proportion of the trades that were executed at extreme prices during the flash crash, Ms. Schapiro said. That same month, the SEC passed a rule requiring broker-dealers with market access to implement risk management controls on a pre-trade basis, “effectively banning naked access,” she said.
Last month, the SEC, along with Finra and the exchanges, proposed a “volatility plan,” which would expand on the pilot circuit breaker program. Under the proposal, circuit breaker protection would extend to all U.S.-listed equities.
And it would apply circuit breakers during the opening and closing periods of the day, which currently aren't covered by the pilot program, Ms. Schapiro said.
The proposal also would add a “limit up, limit down” mechanism.
The proposal would cut in half the price parameters that would trigger a trading pause to 5%, from 10%, which “would greatly reduce the scope for sudden price moves,” Ms Schapiro said.
How effective the SEC is in curbing the activities of high-frequency traders largely will depend on what kind of teeth the commission gives these regulations, said Scott Burns, an analyst at Morningstar Inc.
“Mandates without economic incentives are tough to enforce,” he said. “A high-frequency trader may take a slap on the wrist from the SEC for not making a market if he stands to make $1 billion.”
Still, Mr. Burns said he is pleased that the SEC is focused on the issue.
“They really recognize the root of the flash crash and are trying to address those problems,” he said.
E-mail Jessica Toonkel at [email protected].
