It seems that at least once a week we are writing about some shenanigans at the stock exchanges. In the past, we have highlighted conflicts of interests at the exchanges including hidden order leakage, high speed data dissemination to select clients first and mega tier rebates for only the biggest HFT's.
We have long targeted the exchanges/self-regulatory organizations (SRO's) as the center piece of our broken market. In fact, we have a chapter in our book, Broken Markets , titled "The Arms Merchants" where we detail many of the conflicts of interests that exist at the for-profit exchanges. Many of the suggestions that we have recommended to fix our market structure center around changing the practices at the exchanges. These include eliminating the maker taker model, overhaul of exchange order types and restricting of some information from the proprietary data feeds.
There is no doubt in our mind that poorly designed regulation and the actions of the stock exchanges over the past ten years have allowed high frequency trading to dominate the market. The exchanges have allowed their quest for short term profits to cloud their judgement. We have been extremely frustrated that the SEC and other regulators have allowed the exchanges to continue to favor their largest clients at the expense of the overall health of the market.
Well, finally, we may have gotten the attention of someone at the SEC. SEC Commissioner Luis Aguilar gave a speech on Wednesday titled "The Need for Robust SEC Oversight of SRO's" which should be a wakeup call for the stock exchanges. Here are a few excerpts from Commissioner Aguilar's speech which put the stock exchanges on notice:
"SROs have faced increased competition in the markets where they operate. In addition to these competitive challenges, there continues to be inherent conflicts of interests between the SROs’ regulatory functions and its members, market operations, issuers, and shareholders. To stay in business, SROs have to attract order flows, and this may lead to SROs being less inclined to enforce rules vigorously against financially supportive members, issuers, and shareholders."
"The advent of these new competitive challenges and continued conflicts of interests require, among other things, a closer working relationship between SROs and the SEC, and for the Commission to re-evaluate how it can best provide appropriate oversight over SROs."
[Regulators vs HFT Firms Debate:Who Blinks First?]
"Because of the inherent conflict of interests involved in self-regulation, robust SEC oversight over SROs is indispensable."
"SROs must have strong compliance cultures and adequate and dedicated compliance resources to provide the first line of defense; however, when SROs fall short, the SEC needs to stand ready to take action. The SEC’s oversight of SROs is an important component to instill public confidence in the securities industry."
It is very clear from Commissioner Aguilar's speech that the SEC is not satisfied with the exchanges ability to regulate themselves. While it’s been a long time coming, we are glad to finally see that the SEC has decided to get more involved in exchange regulation. The exchanges have no one to blame but themselves for this. They could have prevented this public admonishment had they not been so greedy and short sighted. We believe that the current exchange business model, which developed since they went for-profit, is no longer sustainable. Let's hope they have another business plan ready. Joseph Saluzzi is partner, co-founder and co-head of equity trading of Themis Trading LLC, a leading independent agency brokerage firm that trades equities for institutional money managers and hedge funds. He is also the co-author of Broken Markets -- How High Frequency ... View Full Bio