Ted Kaufman - United States Senator for Delaware

SEC Bans Brokers From Permitting Unsupervised Trades by Clients

Source: Bloomberg

By Jesse Westbrook

November 4, 2010

The U.S. Securities and Exchange Commission banned brokers from letting clients make unsupervised trades on stock exchanges amid concern that a rogue transaction could roil markets.

SEC commissioners voted 5-0 today to approve a rule that targets so-called naked-sponsored access, in which a customer uses a broker’s identification code to trade directly on exchanges while bypassing security measures. The rule, which subjects all transactions to pre-trade risk controls, was proposed in January after SEC officials expressed concern that a computer malfunction or human error might trigger an order that would erode a broker’s capital.

The SEC is cracking down on computerized trading that relies on speed to make money after lawmakers such as outgoing U.S. Senator Ted KAUFMAN, a Delaware Democrat, questioned the agency’s oversight of electronic markets. The May 6 crash, which erased $862 billion of value from equities in 20 minutes, also led the SEC to increase scrutiny of high-frequency trading.

“The potential impact of inappropriate trading has become more severe as our securities markets have become more automated, and high-speed trading more prevalent,” SEC Chairman Mary Schapiro said at today’s meeting. “Additionally, as the events of May 6 demonstrated, the financial markets today are highly inter-connected, and an event in one market can rapidly spread throughout the financial system.”

Naked access is used by traders whose strategy of buying and selling thousands of shares in milliseconds would be slowed if they executed through a broker. It accounts for about 38 percent of U.S. equities trading, according to a December study by Aite Group LLC. So-called sponsored access, in which traders use brokers’ identification codes but are still subject to risk measures, represents about half of U.S. volume, the report said.


In a separate vote today, SEC commissioners unanimously approved a proposal to expand the agency’s ability to reward whistleblowers who provide tips on fraud. The rule, which stems from the Dodd-Frank financial regulation law, empowers the SEC to pay tipsters in cases where sanctions exceed $1 million.

Under the proposal, the agency can give claimants as much as 30 percent of the money it collects from fines or recouping ill-gotten gains. Awards are currently capped at 10 percent of collected funds and limited to insider-trading cases.

Republican commissioners Kathleen Casey and Troy Paredes expressed concern that bigger awards might lead to an avalanche of frivolous tips that would divert the agency’s enforcement division from investigating legitimate cases.

The SEC must also ensure that its efforts to gather tips don’t undermine programs set up by companies to investigate whistleblower complaints internally, Paredes said.

‘Reasonably Designed’

The SEC’s market-access rule requires brokers to implement controls that are ‘reasonably designed” to prevent orders from exceeding credit or capital limits, the agency said in a statement. The measures must also prevent trades that “appear to be erroneous,” the statement said.

“It’s helpful for broker-dealers to have this rule, because it helps to create a level playing field,” said Susan Grafton, a former SEC attorney who’s now at Gibson Dunn & Crutcher LLP in Washington. Firms will no longer be “forced by competition to take on new risk,” she said.

The rule may help prevent errant orders that have triggered trading halts in stocks, David Shillman, an associate director in the SEC’s trading and markets division, said at the meeting.

The halts, which the SEC and stock exchanges implemented after the May 6 crash, pause trading when a company listed on the Standard & Poor’s 500 Index or Russell 1000 Index moves 10 percent in five minutes or less. The circuit breakers have triggered trading halts for 13 companies.

The new risk controls will cost the securities industry about $100 million to implement, SEC officials estimated. Ongoing costs will be about $100 million a year, they said.

‘Original Information’

Under the whistleblower proposal, informants must give the SEC “original information” or analysis that’s not derived from public sources. The information must lead to a successful case being opened or be essential in allowing the SEC to pursue a case that it’s already commenced.

Among those barred from receiving awards would be attorneys who get information from clients, accountants who obtain information through corporate audits and employees who learn of tips because they oversee a company’s internal compliance program. The SEC has been receiving about 100 tips a day since Congress approved Dodd-Frank in July, agency officials said.

The proposal permits SEC officials to consider bigger rewards for whistleblowers who first report complaints to their employers. The provision aims to encourage tipsters to use firms’ internal compliance programs before going to regulators.

The SEC will seek public comment on its whistleblower proposal before agency staff makes any changes. It requires a second vote by commissioners to become a binding rule.


The SEC voted on a separate proposal triggered by Dodd- Frank that requires the agency to prohibit fraud, manipulation or deception in derivatives transactions. Congress took aim at the $615 trillion over-the-counter swaps market after soured trades on mortgage and credit derivatives tipped the U.S. economy into the worst recession since the 1930s.

Derivatives, including swaps, are financial instruments used to hedge risks or for speculation. They’re derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

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