Ever since the so-called Flash Crash nearly three years ago, when stock markets plunged almost nine percent for mysterious reasons, American regulators have sought new means of keeping tabs on trading activity. As a way to increase supervision, the Securities and Exchange Commission called on exchanges last summer to create a proposal for a central database of all trades, a “consolidated audit trail” in industry jargon.
But almost as soon as the exchanges' proposal landed on Tuesday, advocates for greater scrutiny accused the markets of protecting their own narrow interests at the expense of broader market stability.
Under the proposal, the exchanges would manage the very information regulators would use to monitor their activities, raising the prospect that they could withhold sensitive information to shield themselves from oversight.
“We got the fox guarding the henhouse,” said Joe Saluzzi, a partner at New Jersey-based Themis Trading, who has been critical of the U.S. stock market structure. “The exchanges have a vested interest in the current market structure. They like the way it is right now, and they don’t want you to come in here and change the model. If I’m an exchange and I realize one of my systems is doing something that it isn’t supposed to be doing, am I going to want the SEC to know that? Or am I going to try to hide that data?”
Representatives for major stock and derivatives exchanges have countered that they have the clearest sense of the workings of their markets, putting them in the best position to design the database. The SEC intends for the database to "increase the data available to regulators investigating illegal activities such as insider trading and market manipulation," among other important uses.
“For many good reasons including technical and market expertise, the SEC tasked the exchanges to develop and manage the consolidated audit trail process under its oversight and approval,” Richard Adamonis, a spokesman for the New York Stock Exchange, said in a statement. “The proposal, like the entire process, is highly transparent and open for public comment.”
Advocates for tighter regulations have bemoaned the fact that the SEC tasked the exchanges with effective control over the process.
“This shows how, now, there’s just nobody that’s really a regulatory arm of the U.S. government,” said former Sen. Ted Kaufman (D-Del.), who during his brief tenure from 2009 to 2010 lobbied the SEC to consider issues related to market structure a top priority.
“This gets back to the same story, where [the financial industry] says 'We don’t need regulation. Just trust us. It’s going to work itself out.'” And the regulators say 'OK,'” Kaufman said.
Kaufman and others said it’s particularly vexing that the companies that operate stock markets, for-profit corporations that are sometimes owned by larger financial institutions, are being given free rein to design a system that will be used by their regulator to eventually monitor them.
“The venues have so many conflicts of interest, you need a real regulator to do this,” Kaufman said.
The SEC, which will ultimately have to approve the system, declined to comment.
Interestingly, the current chairman of the SEC, Elisse Walter, criticized the agency in July for leaning on the financial industry to develop the monitoring platform.
“History teaches us that this type of advance is not frequently undertaken voluntarily,” Walter said at the time.
Following the release of the proposal, an expert in market technology said it was clear to him that the exchanges had created a document that calls for an audit trail process that will overwhelm the agency with its complexity.
“What that specs are, I don’t want to say they’re 'pie the sky,' but it’s a pretty big wish list,” said Eric Scott Hunsander, CEO of market technology firm Nanex LLC.
“There’s no way what they’re asking for is going to be delivered in the next five years. Actually, there’s no way that will ever be delivered, ever, unless we’re willing to spend the equivalent of landing a man on the moon,” Hunsander said.
Kaufman, the former senator, said he is no expert in the technical aspects of market structure and would not comment on whether Hunsander’s assessments are accurate. But he said it was clear to him the SEC was failing to “protect the credibility of the financial markets.”
Back in 2009, during his time as senator but before the Flash Crash, Kaufman had a meeting with then-SEC chairman Mary Schapiro, where he asked her to address market structure issues like high-frequency trading. Kaufman said that when Schapiro promised to take action, he told her point-blank that he just didn’t believe she was serious.
“She said she was gonna do it, and I was questioning if she would do it. She said, 'Trust me,'” Kaufman said Wednesday.
“I was right. Just look at where we are,” Kaufman said.