Commentary

Securities Regulation Continues to Frustrate

Ask any trader their opinion about regulators at the SEC or CFTC and they’ll respond with variants of one of the following two responses:

1.) “Great people. My son’s godfather is a director at the SEC.” (see article)

Or

2.) “They’re garbage, too busy watching porn to effectively do their job, if at all.” (see article)

These are agencies completely captured by the securities industry, and those traders who happen to be distorting or even blatantly breaking trading laws operate in absolute contempt, thumbing their noses at the sheer ineptitude of the would-be enforcers without any meaningful recourse.

The Wall Street Journal published an article on Friday reporting that the CFTC will begin studying high-frequency trading that takes place on commodities and futures markets.

From the article:

“the CFTC plans to hold the first meeting of a high-frequency trading advisory panel on March 29. High-frequency trading is “taking an even larger role in our market, a bigger impact,” said Scott O’Malia, the CFTC commissioner who is spearheading the push. “You can’t ignore a trading style that occupies 40% of our market on any given day,” he said.”

And:

“Instead of just policing completed futures trades, the Commodity Futures Trading Commission will seek to watch the fleeting buy and sell orders that increasingly influence the market, CFTC Chairman Gary Gensler said in an interview.”

Never mind for a second that Gary Gensler’s previous place of employment was at Goldman Sachs where he worked for 18 years eventually becoming a partner and director of fixed income and currency trading, never mind that. What is of concern and extremely frustrating is that only just now, according these comments, the CFTC has decided to focus on orders and not simply transactions. Also, high-frequency trading is the market, 40 percent by their own admission and I’d argue much higher depending on the metric used. Ignoring trading that occupies nearly the entire market that these agencies are tasked to police is beyond comprehension.

Since the advent of electronic trading, manipulation conducted in markets is done through transactions AND orders. Perpetrators move prices by controlling both the bid and ask side of spreads and move prices without transacting anything in accordance with how their open positions are set up in the market being manipulated and other markets in tandem. If that is difficult to understand, the takeaway is that monitoring orders and not simply transactions is integral to discovering manipulation and consequently enforcing against it.

Anti-manipulation regulation has been in place for nearly 80 years for both CFTC and SEC regulated markets with the passage of the Commodity and Exchange Act and the Securities Exchange Act. Hats off to the ladies and gentleman over at the SEC and CFTC for finally coming around to at least monitoring for it. Using a federal agency measuring stick, taking 80 years to get up to speed may actually be regarded as commendable progress.

If that timeframe is any indicator, it comes as no surprise that the new laws charged to the SEC and CFTC through the financial overhaul bill have not even begun to be addressed.

Recently the Dodd-Frank Act amended anti-manipulation legislation to include the following provision:

“It is unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of the registered entity that-

Violates bids or offers;

Demonstrated intentional or reckless disregard for the orderly execution of transactions during the closing period; or

Is, is of the character of, or is commonly known to the trade as, “spoofing” (bidding or offering with the intent to cancel the bid or offer before execution).”

This provision has been effective since July, 2011 and yet no enforcement has been brought forth despite the language of the rule specifically prohibiting the practices of high-frequency trading. More than 90 percent of all orders entered on the Nasdaq and NYSE are cancelled, and similar percentages of orders for swaps, futures, and other CFTC regulated derivatives are cancelled. The orders are merely entered to influence prices both in the market they are entered and the corresponding markets they directly affect. Those orders are not at all actionable, meaning that even if a trader wanted to trade against them, the “liquidity” that is reported to the exchange is not available to transact. Orders are entered in front of or in fractions of, true orders directly “violating” their intent to transact. Similarly, these orders are not at all actionable and have full intention of being cancelled.

Yet, nothing has been done despite the legislation.

The SEC and CFTC are both requesting to have their budgets increased. The SEC wants a $245 million increase for a budget of $1.56 billion and the CFTC wants a $103 million increase for a budget of $308 million. That’s a 19 percent and 50 percent budget increase respectively.

Why? So they can hire more ex-Goldman and other ex-industry heavyweights to continue to ignore manipulative practices consistent with their history?

These agencies do not need more funding and they do not need new legislation if all that legislation does is provide an excuse to hire more manpower only to sit around ignoring its intent and instead resort to watching porn.

Layering on legislation and layering on inept or corrupt agents defines federal securities agencies. Throwing money at them simply feeds the cause. If financial overhaul was the goal following the crisis, it’d be wise to overhaul what’s broken: the SEC and CFTC.