In a speech this week at the American University School of Law, Elisse Walter, chairman of the Securities and Exchange Commission, offered some insight into how the Commission may start to tackle regulations for high-frequency trading. She also talked up new high-tech systems it will deploy to keep pace with those used by the entities it oversees.
Walter, who will soon be replaced as chairman if President Obama's nomination of former New York prosecutor Mary Jo White is approved by the Senate, said she has directed her staff to accelerate work on an initiative called Reg SCI, which would mandate standards and testing requirements for exchanges.
Responding, in part, to the “Black Monday” crisis 25 years ago when investors overwhelmed automated systems during an historic sell-off, the SEC issued an Automation Review Policy for ensuring the stability and security of emerging, interlocking technologies. Market participants were asked to test their systems and alert the Commission to any problems they discovered. These expectations, however, were detailed as policy statements, not rules. Compliance was not a binding requirement.
Picking up where her predecessor, Mary Schapiro, left off, Walter is pushing to see those voluntary guidelines become mandatory rules. She expects that a new rule would require that the core technology of the exchanges, alternative trading systems, and clearing agencies meet established standards. They would also be required to conduct business continuity testing, and provide notifications of disruptions and other problems.
Walter said the Commission will be using some new technology of its own to better monitor high-speed transactions. Among those initiatives is the Market Information Data Analytics System, code-named MIDAS, which can capture all orders posted on the national exchanges, all modification and cancellation of those orders, all trade executions, and all off-exchange executions. She said it provides an “unprecedented aggregation of trading information data” that allows the Commission to better monitor and understand mini-flash crashes and detect illegal behaviors.
“It will give us dramatically better insight into the function of a market that moves many millions of dollars in millionths of a second,” she said. “It will be like the first time scientists used high-speed photography and strobe lighting to see how a hummingbird's wings actually move. MIDAS will enable us to examine the fundamental mechanics of today's high-speed markets in a way that has never been done at the agency.”
In July, the Commission also approved a rule that requires the national securities exchanges and other self-regulating financial organizations to establish a market-wide consolidated audit trail (CAT). Where MIDAS collects public data, CAT will capture non-public data as well, not just trades and when they were executed, but also, for example, the identities of the parties to the trades. Walter described it as the “backbone for future surveillance and policy making efforts.”
Among the other technology being deployed by the Commission, that Walter described:
- A system to analyze routine regulatory filings and, using peer comparisons, will flag for review those that are incomplete, inaccurate, or feature fraudulent accounting practices.
- Analysis tools that use performance data to identify hedge fund advisers worthy of further review. For example, if an equity fund consistently and suspiciously outperforms similar funds over a period of years, it would be identified and examined.
- Audio-searching technology that allows phonetic searches of voice recordings can collect evidence from conversations between brokers and their customers without staff having to listen to hundreds or thousands of hours of talk.
Walter also touted new technology the Commission can use to translate thousands of phone records or lines of trading data into a visual representation that maps “previously undiscovered relationships between participants in complex sets of transactions, and perhaps conspiracies.” Last year, the SEC used this tool to hunt down an insider trading network of nine people that stretched from Philadelphia to Hong Kong.