SEC Officially Bans Trading in the Nude

By JESSICA HOLZER
The Wall Street Journal
11/3/10

WASHINGTON—The U.S. Securities and Exchange Commission voted Wednesday to bar broker-dealers from granting traders unfiltered access to an exchange or trading venue, a move aimed at preventing a trading error from causing a severe market disruption.

"Naked access" lets traders buy and sell stocks on exchanges using a broker's computer code without requiring them to filter through the broker's systems or undergo any pre-trade checks.

Such trading arrangements have exploded with the growth of high-frequency trading firms, which often don't want to be bogged down by a broker's controls. In some cases, brokers rely on assurances from traders that they have their own controls in place.

The SEC voted unanimously Wednesday to adopt a proposal it made in January requiring brokers to put in place risk controls and supervisory procedures relating to how they gain access to the market.

The requirements apply to all brokers, regardless of whether they sponsor customers seeking to access the market via the broker's systems. The rules effectively ban naked access because they require traders to funnel their orders through the brokers risk controls.

The rules aim to reduce brokers' financial exposure, since brokers are legally responsible for all trading activity that occurs under their codes.

Aiming to fill a potential loophole in the original proposal, the new rule also applies to alternative trading systems that offer market access to entities that aren't brokers.

The SEC, in a fact sheet describing the rule, said the procedures will help to prevent erroneous trades and shields against breeches of credit limits by traders, as well as failures to comply with regulations.

"The potential impact of a trading error or a rapid series of errors, caused by a computer or human error, or a malicious act, has become more severe," the SEC said.