Securities and Exchange Commission Chairman Mary Jo White laid out a proposal Thursday that aims to help regulators cope with a technological revolution that has turned stock trading into an endeavor driven and dominated by fast computers — sometimes with disastrous results.
It could take years before the various initiatives she outlined come to fruition, if they take off at all. But the plan marks a significant first step for an agency that’s struggled to keep up with the technological prowess of the traders and markets it oversees.
Here’s a look at two of the core areas White said she wants to tackle:
High-frequency traders. These are the people who now dominate the market, accounting for at least half of all activity on U.S. exchanges. Using complex computer algorithms, they trade at blink-of-an-eye speeds, generating millions of messages per second during peak hours about what they’re buying, selling or canceling.
For years, the SEC and other regulators have been questioning whether the value these traders bring to the market outweighs the potential problems they can create, such as perceptual issues of market fairness and technological glitches that can trigger huge market disruptions.
Supporters of the technology say this type of trading lubricates the stock market’s engine, providing liquidity and helping cut transaction costs for long-term investors. But critics have been quick to blame these traders for market disruptions and often accuse them of gaming the system. Author Michael Lewis did just that earlier this year when he said U.S. markets are “rigged” in favor of high-speed traders, whose technology enables them to gain split-second trading advantages over other investors.
In April, the Justice Department said it was investigating whether high-frequency traders are violating insider-trading laws, and the SEC is working on a parallel investigation.
But White has repeatedly denied that the markets are rigged, and did so again Thursday, when she spoke at a New York conference. “The current market structure is not fundamentally broken, let alone rigged,” she said.
White said empirical evidence suggests that investors — both retail and institutional — are doing better in today’s algorithmic marketplace than they did in old manual days. The cost of executing large orders was more than 10 percent less for institutional investors in 2013 than in 2006, when high-frequency trading was much less prevalent in the market, she said. Costs also have come down sharply for retail investors.
That does not mean the current market structure is “without issues,” White said.
White is proposing that all high-frequency trading firms register with regulators as broker-dealers, which would obligate them to meet certain financial conditions and abide by other rules. Most of these traders are already registered.
White also has directed her staff to develop an “anti-disruptive trading rule.” If adopted, it would prohibit certain types of legal (but aggressive) trading activities at times when the market is excessively volatile or fragile.
Dark pools. Roughly 35 percent of trades take place off of the nation’s public exchanges and on alternative trading venues, including “dark pools.”
In these lightly regulated dark pools, the identities of the buyers and sellers of a stock are masked from the public, and information on how these venues operate is limited, though a few of them this week started voluntarily disclosing how they work.
White said there needs to be more transparency. “Transparency is one of the primary tools used by investors to protect their own interests, yet investors know very little about trading venues that handle their own orders,” she said.
Some institutional investors hide their trades in dark pools to disguise what they’re doing from high-frequency traders and other market participants. They say they get a better deal if other market players can’t detect how much of a stock they’re buying or selling, for instance.
The Financial Industry Regulatory Authority, the self-regulatory body that oversees broker-dealers, recently began collecting weekly stock-by-stock trading volume data from dark pools. It disclosed the data in the aggregate for the first time this week.
White said she supports having FINRA collect and disclose trading volumes for other alternative trading venues as well, and for broker-dealers.
Dark pools and other alternative trading venues already provide the SEC with some information on how they operate. But White has asked her staff to come up with recommendations on how to add to that information, and even make it public, so that investors can assess whether their brokers are doing a good job on their behalf when they place large orders in dark pools.