The head of the Securities and Exchange Commission called Thursday for new rules governing the structure of financial markets, acknowledging that high-speed trading and the largely unregulated trading areas called “dark pools” may be working against ordinary investors.
Speaking at a New York conference, SEC Commissioner Mary Jo White couched her suggested changes as “enhancing” the structure of stock markets. But White made it clear that the rules governing financial exchanges are outdated.
Much of the focus was on computer-driven trading, which White said had generally been positive by lowering costs for all investors. But as algorithms now drive stock-market trading, “not all segments of the equity markets have equally shared the benefits from the positive market trends,” she said, “and that disparity may have increased in recent years.”
White’s remarks come amid the controversy raised in the best-selling book “Flash Boys,” by noted financial author Michael Lewis. In the book, Lewis said companies engaged in high-frequency trading fleece ordinary investors by driving up the price a fraction in a matter of milliseconds.
That fraction adds up to billions of dollars a year and it happens in ways investors never see. It led Lewis to assert that markets are “rigged” against ordinary investors.
Much of what White proposed Thursday dealt on the margins of the allegations raised by Lewis. Today’s rules apply to yesterday’s markets, she acknowledged.
“As a general matter, many market-structure rules and industry practices were developed with manual markets in mind,” she said, referring to a time before computer-driven trading took root. “They cannot be expected to optimally address all of today’s markets.”
The SEC doesn’t want to “roll back the technology clock,” White said, but it’s actively assessing “the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them.”
The SEC staff is being asked to develop a recommendation for a rule to limit the use of computer-driven strategies that exacerbate stock swings in periods of stock-price volatility.
And the staff will clarify rules to ensure that high-frequency trading firms that engage in trading on their own behalf – called proprietary trading – would be subject to SEC regulation.
High-speed traders are able to get information about trades being placed more quickly than most investors, in part because they’ve been allowed to co-locate at the site of stock exchanges, giving them speed advantages measured in tenths of a second or less. They “front-run” orders being placed by pension funds or other large institutional investors.
Front-running happens when traders armed with information about a pending sale buy the number of shares sought and then sell them to the intended buyer seconds later at a slightly higher price.
“The question they should be asking is: Why does the SEC allow co-location?” said John Coffee, a professor at Columbia University in New York and a frequent witness before Congress on securities-law matters. “When you pay a lot of money to the exchange in exchange for location, you get the exchange’s loyalty and they favor you.”
The SEC rules don’t address the most direct allegations made by Lewis, Coffee said, and point more to the 2010 “flash crash,” when a computer glitch briefly shut down financial markets.
One hot topic in the Lewis book was “dark pools,” private trading venues run mostly by giant Wall Street banks such as Goldman Sachs.
Lewis said nine Wall Street banks controlled 70 percent of stock-market orders, and also ran their own “dark pools” where trading occurred. In her speech, White noted that 35 percent of all stock-market trading volume is done in dark venues, up from 25 percent four years ago.
“Dark pools” don’t disclose the identities of participants to the public, and they limit information about how the venues operate. McClatchy has reported how the trading of contracts for oil in “dark pools” may be driving up oil and gasoline prices.
“Transparency has long been a hallmark of the U.S. securities markets, and I am concerned by the lack of it in these dark venues,” White said, adding that she’s open to expanded disclosure requirements for big players in the “dark pools.”