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.

SEC close to banning being naked while trading

By Jessica Holzer and Jacob Bunge
Of Dow Jones Newswires
10/22/10

WASHINGTON -(Dow Jones)- The Securities and Exchange Commission staff is close to finishing work on a rule that would ban "naked access," which allows some traders to do business anonymously, people familiar with the matter said.

Naked access, offered to customers by some major banks and brokerage firms, allows traders to buy and sell stocks on exchanges using a broker's computer code, which can shield their identity from regulators and exchanges.

The arrangement, used by some quantitative trading firms, lets them avoid being slowed by a broker's risk controls and helps to mask their trades from brokers running their own proprietary trading groups.

The move comes as U.S. securities regulators pursue a broad revamp of U.S. market structure, initiated following the financial crisis of 2008 and hastened by the "flash crash" of May 6.

In recent months the SEC and Commodity Futures Trading Commission have collaborated on a range of new trading rules aimed at controlling price swings in stocks, firming policies for voiding trades and tightening guidelines for market makers.

Banning naked access has been a priority of SEC Chairman Mary Schapiro, who has described the practice as "giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied."

Chief among the concerns of regulators and lawmakers like Sen. Ted Kaufman ( D., Del.) is that a trading firm utilizing such access could ring up losses to such an extent that the broker providing the access could be destabilized. Brokers offering sponsored access typically are exposed to losses if the customer can't cover them.

Regulators also are wary that a trader doing business without proper risk checks in place could enter trades of such magnitude that the broader market could be affected. The SEC and CFTC early this month released a long-awaited report analyzing the flash crash that identified a major trade in stock index futures as a key component of the session's volatility.

The SEC staff is "very far along" in drafting a final rule banning the practice, one person familiar with the matter said, adding that the rule will be very similar to the SEC's original proposal on the issue.

The regulator in January proposed requiring brokers to subject clients to pretrade checks before giving access via their codes.

Traders would then need to direct market orders through the broker's computer systems before the orders go to the exchange, in an arrangement known as " sponsored access." By contrast, naked-access orders are largely subject to checks that occur after trades have been executed.

A final rule would have to be approved by a majority of the five-member commission.