SEC Eyes Technology, Volatility


The U.S. Securities and Exchange Commission is methodically going through its to-do list.

At a Security Traders Association of New York event last week,  David Shillman, associate director in the SEC’s Division of Trading and Markets, said rulemaking is focused on technology, volatility, complexity, plugging regulatory gaps, and small-cap trading.

If unchecked, the rapid pace of technological advancement can lead to excessive risk which the Commission won’t tolerate, Shillman said.

New regulations will build off existing rules such as Regulation Systems Compliance and Integrity, and would focus on setting policies and procedures at key market infrastructure such as exchanges, dark pools and market utilities. Any new rules or proposals would be flexible in design and ideally establish market standards for policies and technology.

Reg SCI “encompasses a lot of work and (it) is going well,” Shillman said. “We are beyond the first set of implementation and getting examinations up and running. The next portion of rulemaking will focus on capability standards such as backup of key data and disaster recovery.”

Market volatility is another area of SEC review, Shillman said. In particular, the expansion of the current limit up/limit down price band mechanisms seem a no-brainer. “There’s a proposal to extend the current limit up/limit down pilot for another year or two,” he said. “There is some fine tuning of the pilot that needs to be done.”

The issue of market complexity would be addressed as it has been historically, Shillman said, by increasing transparency. One area of new focus will be better understanding how brokers and dark pools operate, as they are less transparent than public exchanges.

“We’re really going to take a look at the sell side and those affiliated with them,” Shillman said. “We want to look at the brokers’ affiliate firms, the dark pools and routers — how they operate and in more detail than before.”

Currently, the SEC has a proposal on the table in the form of Reg ATS, which at over 600 pages, already looks comprehensive in the type of information regulators want. Up until now, dark pool operators have only had to register their venues via Form ATS – which can often only be a one page document with few specifics and little uniformity between dark pool registrants.

Also coming soon to the market is a variant of Rule 606 -Institutional 606. Rule 606 calls for broker-dealers to publicly disclose, on a quarterly basis, certain statistical information relating to their most significant execution venues any order that a customer has not specifically instructed to be routed to a particular venue for execution. Rule 606 applies to retail orders only while Institutional 606 will apply to the the buy side.

“There’s been a lot of concern by the buy side on how their orders are routed — why an algo chooses a particular venue over another or how algos resolve conflicts,” Shillman said. “We’re working on this now and expect something fairly soon.”

He added that the SEC is working with Sifma to develop an Institutional 606 rule template now as well as updating Rule 606. It was Shillman’s opinion that Institutional 606, along with the Reg ATS proposal and an updated Rule 606 would all work in concert to address a large part of the market’s desire for transparency.

By way of plugging regulatory gaps, Shillman said that the Consolidated Audit Trail proposal would go a long way toward helping regulators either tailor existing regulations or form new ones.

“We are doing a formal economic analysis which you will all be able to see,” Shillman said. “We hope to soon get the audit trail plan out for comment.”
Other gaps, he added, were targeted at making sure proprietary trading firms are registered as broker-dealers. Currently, prop traders do not have be registered with Finra and have used loopholes in Rule 15-C 3-1 to avoid registration.

Yet another gap the SEC will close has to do with algorithms and accountability. Shillman said that in order to prevent unchecked electronic trading or a so-called algo gone wild, the Commission wants to know more about the popular trading tools, such as an algo’s developer, the employee who approved its usage and the state where the actual code is kept.

“This idea is in development and we hope to have a rule proposal profile out later this year,” Shillman said.

The final regulatory focus will be on small-cap stocks, as while the JOBS Act has focused on getting companies to market and incentivizing brokers provide research on lesser known companies, nothing is being done to actually get them trading.

Featured image by James Thew/Dollar Photo Club

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