Ted Kaufman - United States Senator for Delaware

Kaufman Statement on June 2 SEC Roundtable on Market Structure Issues

June 1, 2010

WASHINGTON, D.C. — Senator Ted Kaufman (D-DE) issued the following statement prior to tomorrow’s Securities and Exchange Commission roundtable on market structure issues, including high frequency trading:
“In assessing the breadth of each panel invited to participate tomorrow at the SEC roundtable, there are two questions to ask:  Will the participants represent a broad range of industry members and outside experts? And will each panel present a wide and fairly balanced range of viewpoints?  As I said last Thursday, the Commission at a minimum should ensure that all of the panels demonstrate “some semblance of balance” between industry participants who profit from the current market structure and critics who fault the markets as overly fragmented, conflicted and unfair.
“With preliminary reports last week showing the make-up of the high frequency trading panel to be dramatically out of balance, the Commission, apparently in response to my concerns, moved one of the biggest past advocates for high frequency trading to another panel and added a mutual fund critic as well as another representative from the academic community.  That means on the high frequency panel, two are previous critics of high frequency trading and two are academics.  Of the other five on the panel, four make their living either directly or indirectly through high frequency trading and all five, for the most part, have been staunch defenders of the status quo.  Draw your own conclusions about whether this is a ‘balanced’ panel.  
“The panels would certainly have benefited from a few more high frequency critics (like Rich Gates of TFS Capital, O. Mason Hawkins of Southeastern Asset Management or Bob Bright or Dennis Dick of Bright Trading) as well as representatives of a pro-investor group, such as the AFL-CIO from the perspective of pension funds, or David Weild of Grant Thornton, which has conducted studies on whether the current market structure is having a devastating effect on Initial Public Offerings (IPOs) and capital formation.  
“Candidly, I remain deeply troubled that the Commission under the glare of public scrutiny had to scramble belatedly to ensure that these panels pass even minimal criteria for balance.”
Kaufman also outlined three larger issues he believes the SEC must address:

(1)                         Breaking the “Closed Loop” of Rulemaking, i.e., Evidenced-Based Rulemaking When Only Wall Street Controls the Data

The SEC must base its rulemakings on data and evidence.  That is a problem when (a) it doesn’t collect meaningful data about high frequency trading – that is what the proposed “large trader” rule issued on April 14 is meant to rectify, when if finalized and implemented the SEC will for the first time “tag” and collect data at the time and customer level about high frequency trading practices; and (b) no one has access to that data outside the high frequency trading firms themselves.
Currently it is a “closed loop” where the SEC is almost exclusively dependent on the entities it regulates for analysis and evidence.  What we need is for the SEC to require 100% tagging of trades (equity and derivative) and messaging, sent back to the investor, and then to disgorge this data into the public marketplace on a delayed basis.  We don't know what we don't know means systemic risk.
To address this major gap, the financial reform bill passed by the Senate includes a new Office of Financial Research within the Treasury Department. The new office would have the authority to collect and analyze financial data in order to identify and assess incipient risks in the system.  It would also publish databases on financial institutions and contracts, which would facilitate further analysis by academics and other independent reviewers. I would hope that analyzing the systemic risks associated with high frequency trading would be a top priority of the new office.     

(2)                         Academics and Private Analytic Firms Need to Play an Important Function

Only after meaningful data is collected and released to the marketplace can academics and private analytic firms provide additional objective evidence to the SEC about market structure issues.  
The academics (and also the private analytic firms that work for the buy-side) should be best positioned to frame (a) the post-May 6 issues, especially the disappearance of liquidity, and (b) what data is needed to conduct meaningful empirical analyses to resolve key issues in the debate.
Again, the key point is that we need to get meaningful ("large trader" at time of order and customer level) data to the academics and others because in my view they are currently unable to verify empirically most of the key questions.  
If anyone in the aftermath of May 6 jumps to conclusions based on broad market data, in my view that will be disappointing, premature and superficial.  Or, ideally, the academics and buy-side analytic firms  will educate everyone on what data is available and meaningful in answering certain questions as well as what data is not available that is necessary to measure other effects.  
(3)                         Costs Should be Allocated Fairly

The SEC may need to take further rulemaking.  Without prejudging what those rules should be, to me it is obvious that regulators must address the burgeoning message traffic and cancellation rates in the current marketplace.  While cancellations are not inherently bad – potentially enhancing liquidity by affording automated traders greater flexibility when posting quotes – their use in today’s marketplace is clearly excessive.  At a minimum we need a system (as a growing number of people are proposing) whereby exchanges and market centers are mandated by rule to allocate costs at least partially based on message traffic share rather than traded volume market share.  
If the SEC adopted a similar system for the new audit trail, high frequency trading firms – some of which cancel hundreds of orders for every one transaction – would have a significant incentive to become more efficient. This would greatly reduce message traffic, system stress and marketplace noise, and would make the markets easier for regulators to surveil as well as add a much needed degree of fairness.



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