Tuesday, September 15, 2009

Regulators Eye Dark Corners Of U.S. Stock Market

. Tuesday, September 15, 2009

By stockOzone team

In obscure corners of the U.S. stock market -- where "flash orders," "dark pools" and other controversial practices thrive -- regulators are trying to shine a light to guard against unfair dealing.

But a crackdown by the U.S. Securities and Exchange Commission, sought in recent months by some top lawmakers in Washington, won't come quickly and may not be as comprehensive as some desire.

The market rule-making process at the SEC is long and time-consuming. And while some trading practices are under the gun, the overall market has been sound throughout the financial meltdown, helped, many argue, by its embrace of the complex electronic trading at the center of the controversy.

Exchanges, brokerages and other market players have catered in recent years to so-called high-frequency traders -- firms that use computer algorithms to make hair-trigger trades in small amounts of stock. This has spawned other controversial practices, but has also given the U.S. stock market unrivaled liquidity.

"The tendency is to leave the market alone. As long as it's working, don't try to play games with it," said Fred Lipman, a partner at Philadelphia law firm Blank Rome who has written several books on capital markets.

"These algorithms and computer programs are ... a fact of life," he said, and regulators "are going to do just enough to keep the politicians off their backs."

Unlike the high-profile financial regulation overhaul being sought by the Obama administration, the SEC's market-structure initiative targets behind-the-scenes Wall Street practices.

Some observers say the next big scandal lurks in this structure, which has evolved mostly unobstructed since 2004, when sweeping rules ensured all orders are executed at the best price. That helped seed the growth of high-frequency traders, which are now involved in an estimated 70 percent of equity trades.

This summer, Democratic U.S. Senators Charles Schumer and Ted Kaufman called for a review of high-frequency trading and other practices that they said could exploit smaller investors and put the stability of markets at risk.

Banks such as Goldman Sachs, hedge funds like Citadel, and private marketmakers such as GETCO have been the main target of criticism in recent months, since high-frequency trading came under the spotlight after a former Goldman computer programmer was charged with stealing trading code.


SEC staffers are exploring possible recommendations to the agency this fall on market-structure issues, including high-frequency trading, said SEC spokesman John Nester.

He said the agency is also probing aspects of trading and transparency at more than 40 U.S. "dark pools," where large block trades are done away from central exchanges.

Also under SEC scrutiny: "naked access," where a broker allows a customer to use the broker's name to get direct access to markets; and "co-location," in which exchanges like NYSE Euronext and Nasdaq OMX rent space to firms, which put their computers next to the exchanges' trading engines to shave valuable microseconds from trading time.

Regulators have said little publicly about high-frequency trading, suggesting they are loath to tamper with a phenomenon that the industry says makes trading in U.S. markets relatively easy.

"It takes great wisdom to not act. If regulation is wrong, the goose that laid the golden egg might die," said former Nasdaq Stock Market President Alfred Berkeley, who is now chairman of block-trading platform Pipeline Trading.

One high-frequency trader, who wasn't authorized to speak on the record, said, "It's kind of a witch hunt. High-frequency traders provide a boatload of liquidity, and that's why the U.S. markets are the tightest, with the most volume ever."


SEC Chairman Mary Schapiro has said the investor protection agency is crafting a plan that would "eliminate the inequity that results" when exchanges "flash" buy and sell orders to member firms before routing them to the wider market.

Schumer told Reuters on Thursday, "We continue to believe ... that a process is under way to end the unfair practice of flash trades."

The SEC is scheduled to meet Sept. 17 to consider restrictions on "flash orders."

Disclosure: Author does not own any of the stocks discussed here.

Bookmark and Share


Post a Comment

Visit blogadda.com to discover Indian blogs