Great read from another iHub Board, especially for those insisting that TOFS and other pennies are not being shorted/manipulated...
SEC Pushes Plan for Audit System
SEPTEMBER 21, 2011
By SCOTT PATTERSON
U.S. regulators, responding to concerns about their ability to keep pace with fast-evolving markets, are pushing forward with a plan to build a multibillion-dollar computer system to monitor stock trading in real time despite criticism from traders who could foot the bill.
The Securities and Exchange Commission first proposed the system, called the consolidated audit trail, or CAT, more than a year ago. Now, it expects to issue a detailed blueprint for the project within the next few months.
The SEC won’t pay for the project. Instead, the agency will require stock exchanges, brokerage firms and the Financial Industry Regulatory Authority, or Finra, which oversees the brokerage industry, to cover the tab. The cost likely would be passed on to investors and traders, according to industry observers.
Critics in the brokerage industry said those costs could damage the market by imposing fees on high-volume traders, making their activities so expensive they might pull back from trading, removing liquidity from the market, or move overseas.
Many trading orders aren’t charged a fee. If the system is implemented, brokerages and Finra would decide what fees to charge.
“Liquidity will become thinner” on U.S. stock exchanges if the CAT results in high order fees, said Manoj Narang, founder of Tradeworx Inc., a Red Bank, N.J., firm that uses a high-frequency strategy.
The CAT would give regulators a window into a market driven by computer trading that occurs at speeds too fast for the human eye to track. Average daily trading volume has doubled since 2005 to 8.8 billion shares in 2011, according to Tabb Group, which tracks electronic trading.
As market speeds have exploded, so have concerns that some firms may hide manipulative activity inside the blur of trading.
After the Upgrade
The SEC hopes a reboot of its technical powers will help it keep pace with markets.
Now:
Regulators see only a slice of orders
Orders available a day or weeks later
Sudden “flash crash” events difficult to explain
Manipulative computer trades hard to catch
With new system:
All orders captured
Orders instantly available
Volatile moves quickly explained
SEC polices entire market in real time
Source: WSJ research
SEC Chairman Mary Schapiro told Congress in March that the SEC’s ability to collect trading data is “wholly inadequate to the task of overseeing the largest equity markets in the world.”
Now, the SEC often must rely on data from Finra, exchanges as well as firms such as mutual funds and bank-trading desks to track the market. Finra and the exchanges report irregular trading activity to the SEC, which is responsible for enforcing securities laws.
At present, the SEC practically is flying blind because it is unable to track a large amount of trading every day. With a consolidated audit trail, the SEC would be able to directly monitor the market and create systems to catch suspicious activity.
The CAT could let the SEC see all orders placed on all exchanges and identify which firm originated and placed a particular order.
Several financial industry participants have lined up against elements of the plan. While Finra supports many of the goals of a CAT, it said the SEC’s push for a real-time tracking system is misguided.
Finra Vice Chairman Stephen Luparello said the benefit of gathering information in real time doesn’t justify the cost, because there would be few instances in which the system would capture information the SEC could immediately act on.
“What benefit you get by getting that information at three o’clock versus getting it the next day is a little hard to put one’s finger on,” he said.
The idea of devising a CAT system has been considered by the SEC for years, but gained steam after the “flash crash” of May 6, 2010, when stocks plunged in a matter of minutes, only to rebound sharply seconds later. The SEC took months to explain the crash, causing investors to worry that the regulator had lost control of the market it oversees. The SEC said the audit trail, which likely also will track stock-option trading, will enable it to more quickly understand and explain such events. The CAT also could catch manipulative trading activity, the agency said.
Proponents of the CAT said it will give investors more confidence in the market, which could pull in more trading activity in the long run.
Critics, however, worry about the project’s price tag. The SEC originally estimated it at about $4 billion upfront and $2.1 billion annually, far exceeding the agency’s 2011 budget of $1.2 billion. The agency said the cost likely will be lower, but still could run into the billions of dollars.
One way the industry could reduce the cost is by upgrading its own systems, such as Finra’s order-audit trail system. But these and other expenses are expected to be passed on through trading fees.
Some observers said the fees could be assessed on a per-order basis, such as a fraction of a cent per order, because the CAT system would be designed to track order flow, according to market observers. That would impose particularly big costs on trading companies that juggle a large number of orders each day.
Some high-frequency trading firms, which researchers have said account for more than half of all trading in U.S. stocks, place tens of millions of orders every day, canceling the bulk of them, and make profits measured in pennies per trade. Order fees could make their activities far less profitable or even unprofitable. That ultimately could affect regular investors, critics of the project said, because high-speed trading is seen by some as the grease that makes the market’s wheels spin.
Patrick Healy of the Issuer Advisory Group, a firm that consults with companies about their relationships with exchanges, said the SEC could create a “monster that impacts liquidity in a negative way.”
Many industry observers, including Mr. Healy, agree the SEC needs to improve its ability to track computer-driven trading.
Write to Scott Patterson at scott.patterson@wsj.com
AI
