Upcoming Action on Flash Orders May Be Only Beginning, Schapiro Indicates

Regulatory Reform:

Staff at the Securities and Exchange Commission are contemplating regulation to curb not only flash orders, but also other potentially unfair electronic trading strategies, Chairman Mary Schapiro told Sen. Ted Kaufman (D-Del.) in a Sept. 10 letter.

In particular, the staff is reviewing direct market access, high frequency trading, co-location, and related thresholds under Regulation ATS, according to a copy of the letter obtained by BNA on Sept. 14. Although lawmakers and regulators agree that such strategies offer liquidity, their concern is about a few sophisticated traders on Wall Street gaining advanced access to information and profiting before ordinary investors.

Schapiro's letter was a response to Kaufman's Aug. 21 request that the SEC comprehensively study flash orders and the other trading practices before taking action. Sen. Charles Schumer (D-N.Y.) earlier had sought and obtained Schapiro's commitment to possibly ban flash orders. The commission will consider such a proposal at a Sept. 17 public meeting.

Political Independence

While Schumer announced that the ban would be “imminent,” Schapiro has repeatedly pledged that the commission will act only after receiving and reviewing public comment on the proposal. In her letter to Kaufman, she reiterated that the agency will “study all comments very seriously.”

In recent months, Schumer, Kaufman, and other lawmakers have pushed the SEC to further restrict short selling by, for instance, reintroducing the so-called uptick rule. In light of such instances—where Congress has pressed the SEC not simply to act, but to act quickly—American Enterprise Institute's Shadow Financial Regulatory Committee called on the agency to remain politically independent.

At a Sept. 14 meeting, the SFRC, comprised of financial experts, referred to Schumer's announcement of an imminent ban on flash orders as an example of “inappropriate” congressional pressure, and commended Schapiro's response to it. The contention that flash trading harms investors “is not at all clear,” the committee said, insisting that the SEC base any action on “professional judgment underpinned with careful empirical studies.”

Similarly, SFRC expressed scepticism about the “motivation” behind the SEC's proposals to impose some sort of price test on short selling and called for “careful economic analysis” before finalizing such proposals. Prior to repealing the uptick rule in 2007, the SEC carried out what Chester Spatt—a member of SFRC, professor at Carnegie Mellon University, and former chief economist at the SEC—described as a “controlled experiment” on its impact.

At the time, the SEC said that its study revealed the ineffectiveness of price tests, such as the uptick rule, on market volatility. Spatt said that the SEC should not reimpose that or a similar rule without conducting another study, because doing so would mean dismissing the 2007 study's “very clear results.”

Consumer Protection or Bureaucracy?

Addressing other controversial financial regulatory reform proposals, the AEI committee partially endorsed the idea of a Consumer Financial Protection Agency. Given its conservative roots, SFRC expected that its support of the idea would elicit surprise. Other conservative groups, such as the U.S. Chamber of Commerce, are vigorously opposing H.R. 3126 to create a CFPA, on the ground that it would generate more government bureaucracy, hinder financial innovation, and even impinge on consumers' privacy.

On the eve of the one year anniversary of Lehman Brothers' collapse (last Sept. 15), President Obama Sept. 14 reminded Wall Street about his proposals for change, which he first announced in June and which included the CFPA. Since that time, the Treasury Department has sent Congress draft language for CFPA and other reform legislation.

For its part, SFRC supported more, centralized consumer protection because banking regulators have “generally done an inadequate job of protecting consumers, for example, from subprime mortgage lenders (especially those regulated at the state level.” The CFPA should primarily seek to ensure that consumers receive “sufficient information about financial products,” so that they can make “informed decisions.” If created, the new agency must simplify current disclosure requirements so that consumers no longer have to “wade through mountains of paper and legalese.”

Nonetheless, AEI's committee of financial experts also expressed concern about legislative language. The administration's draft recommended that the CFPA should curb “unfair, deceptive and abusive” acts or practices. SFRC had no qualms with the terms “unfair” and “deceptive,” saying they are firmly rooted in case law and in the statute led to the Federal Trade Commission. By contrast, the term “abusive” is more ambiguous and would allow the new agency too much discretion, Robert Eisenbeis—SFRC member and chief monetary economist at asset manager Cumberland Advisors, said. The committee suggested excluding the word in upcoming legislation.

Markup Uncertain

Although Congress has been back in session for more than a week, it has not yet planned hearings to resume consideration of financial regulatory reform. Some believe that the administration's concurrent push to overhaul the health care system has eclipsed financial regulatory reform. Democrats have pledged to accomplish both goals by the end of the year. Failure could cost them their congressional majority in 2010 mid-term elections.

While AEI's committee indicated that a markup of H.R. 3126 could take place as early as Sept. 23, Steve Adamske, a spokesman for Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, told BNA that a markup session has not been scheduled.

By Malini Manickavasagam

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