The SEC’s Mary Jo White Punts on High Frequency Trading and Abandons Securities Act of 1934

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SEC chairman Mary Jo White spoke on Thursday about high frequency trading. She made clear that she not going to do much to curb it but will engage in more studies so as to look to be Doing Something.

One of the things that is particularly troubling is White’s effort to finesse that she’s abandoning one of the foundations of securities laws in the United States, The Securities Exchange Act of 1934. John Hempton, who was a member of Australia’s Treasury, calls the 1934 Act one of the best pieces of legislation ever written.

Notably, the first section of her speech is “Taking Principled Action” (Orwell alert). And she discusses high frequency trading in term of what she sees as critical criteria, such as fairness, market structure, but only in terms so vague as to be obfuscatory:

First, we must evaluate all issues through the prism of the best interest of investors and the facilitation of capital formation for public companies. The secondary markets exist for investors and public companies, and their interests must be paramount.

Second, we must account for the varying nature of companies and products, with a particular sensitivity to the needs of smaller companies. One market structure does not fit all.

Third, our review of market structure must be comprehensive. We must test our assumptions about long-standing rules and market practices. Past decisions must be reevaluated in light of current conditions, and market-based solutions to issues should be explored. Barriers to such solutions must be reviewed, and removed where appropriate.

Why is this troubling The US is a rules based system, not a principles-based system. Perversely, while financiers make an art form of regulatory arbitrage, as in finding an artful path through regulations to do things that might not pass the smell test, here White is reverting to principles, not to update the implementation of the foundational securities laws, but to justify market activities she deems to be generally benign (or alternatively, has no stomach to combat). There’s no reference in the entire speech to the 34 Act, which created the SEC, nor to its key principles, such as “no front running”.

Even more so than Tim Geithner in a March 2007 speech which we found troubling at the time, White treats financial innovation, in this case, high frequency trading (which she repeatedly and misleading conflates with alogrothmic trading, when many algos aren’t high frequency traders) as a fact of life. This is another manifestation of what Lambert has called “code as law”, the tendency of regulators and the courts to make rules and regulations adapt to “innovations,” rather than take the posture that the “innovation” is not allowed to go live unless it fits within existing legal parameters or gets the needed approvals first.

White also goes to some length to depict the impact of high frequency trading as positive, such as in terms of lower transaction costs. But as analysts and economists are increasingly pointing out, beyond a certain point (and we seem to be well past there in equity markets), more liquidity is not beneficial. So her “cheaper trading is better” premise which pervades the speech is subject to question (and that’s before the fact that it isn’t obvious how much of that can be attributed to high frequency trading). Indeed, studies have repeatedly found that overtrading diminishes returns. Cheap trading makes it seem low cost to act on impulse; higher trading costs would lead to more deliberation.

There is also the not-trivial matter of the SEC’s culpability for allowing high frequency trading to flourish. The agency allowed co-location of servers and payment for order flow. two dubious practices that critically important to the operation of high frequency traders. White is new to the agency. White didn’t have to defend the policies and inaction of her predecessors, but she’s clearly falling in line with the status quo. For instance, White stated:

All of these market quality metrics show that the current market structure is not fundamentally broken, let alone rigged. To the contrary, the equity markets are strong and generally continue to serve well the interests of both retail and institutional investors.

That’s an obvious rejection of Michael Lewis’ claim.*

Finally, White bizarrely makes only the most oblique references possible to the flash crash and insists market structure is fine. She looks to comparisons of various averages over time, like order execution costs in light of average volatility measures.

The problem with that is it completely misses the issue of robustness. The old market structure, which she sniffingly depicts as “manual” had specialists who were obligated to make markets. As quite a few academics have pointed out, with compelling analysis to support their views, high frequency trading provides junk liquidity: abundant liquidity when you don’t need it, when markets are functioning normally, and liquidity drainage when markets are volatile (White did not discuss how high frequency impacts roiled markets).

Now that isn’t to say that White said she’d do nothing in her speech, but she clearly does not intend to do much. The most important concrete step is high frequency traders should be required to register as broker-dealers. The SEC will also require more disclosures (more on that shortly). But she’s mainly going to get more data and study the issue more. This is not encouraging. First, this looks to be a cynical move to push the time frame for any further action so as to allow the Flash Boys-induced furor to die down completely. Second, as any student of financial regulatory non-reform will tell you, studies allow the industry oodles of time to lobby, both to try to influence the study design, then to argue with findings, then to argue with proposals based on the findings. That’s why Dodd Frank authorized so many studies, to make sure the reforms were diluted.

Even Matt Levine, who is notably Wall Street friendly, made it clear that it was obvious what White is up to.He discussed at length what you’d do if you were concerned about high frequency trading, which is act like Eric Schneiderman**:

New York Attorney General Eric Schneiderman, for instance, pretty clearly believes that high-frequency trading is Bad. He thinks the whole thing is “Insider Trading 2.0.” So his goal seems to be to eradicate it entirely, by going after direct feeds from exchanges and co-location and even just the continuous trading of stocks.5 In Schneiderman’s ideal world, speed would simply be eliminated as a trading advantage.

That is not Mary Jo White’s world, and it shows in her proposals for improving the markets. If you think that the current HFT business model is basically good for the world, then you will be hesitant to make fundamental changes to it. And if you’re the SEC, and you’re under a lot of Michael-Lewis-driven pressure to make fundamental changes to market structure, what do you do?

Disclosure. You do disclosure. To be fair, disclosure is the SEC’s answer to most questions, but it’s especially the answer to questions that the SEC doesn’t especially want to talk about.

So, for instance, one concern that investors have is that high-frequency traders use faster direct feeds from exchanges to pick off investors who rely on the slower, official consolidated data feed.6 One way to resolve this would be to ban speedy direct feeds, which is more or less what Eric Schneiderman wants.7 Here’s Mary Jo White’s approach:

I am also asking the exchanges and FINRA to consider including a time stamp in the consolidated data feeds that indicates when a trading venue, for example, processed the display of an order or execution of a trade. With this information, users of the consolidated feeds would be able to better monitor the latency of those feeds and assess whether such feeds meet their trading and other requirements.

And I am asking the exchanges to develop proposed rule changes to disclose how — and for what purpose — they are using data feeds. For example, which data feeds are used to execute and route orders? And which feeds are used to comply with regulatory requirements, such as trade-through rules? Brokers and investors could use the enhanced transparency to better assess the quality of an exchange’s execution and routing services.

So exchanges can still use slower feeds to price trades while selling faster feeds to HFT firms. They just have to tell tell investors what they’re doing, so the investors can judge for themselves if they’re getting ripped off.

Do you worry that brokers are acting against their customers’ interests in order to take advantage of exchanges’ maker-taker fees and rebates? Maybe you could ban those fees and rebates. Or not. You could just tell people more about them:

I have asked the staff to prepare a recommendation to the Commission for a rule that would enhance order routing disclosures. Rule 606 of Regulation NMS currently requires some public disclosure of broker order routing practices, but it does not cover the large orders typically used by institutional investors. The rule proposal would address this gap by requiring disclosure of the customer-specific information that a broker is expected to provide to each institutional customer on request.

Are you suspicious of dark pools?

Just this week, FINRA began disseminating aggregate information on trading volume of ATSs. This is a useful first step, but ATSs represent less than half of dark venue volume. To remedy this gap, I fully support FINRA in considering an expansion of its trading volume disclosure regime to off-exchange market makers and other broker-dealers.

I also have asked the SEC staff to prepare a recommendation to the Commission to expand the information about ATS operations submitted to us and to make the information available to the public. As you have seen in the recent media, some operators of dark venues began offering greater transparency to their operations this week, but a broader effort is needed.

You get the idea. The SEC’s core view is that the fundamental business model of high frequency trading is fine. There are probably some abuses at the margins, and shedding some light on those margins will be enough to correct those abuses. But for the most part, White thinks, our market structure is nothing to be embarrassed about, so there’s no reason to fear broader disclosure.

Yves again. Levine, in a key footnote, also explains why White’s cheery patter about apparent order execution costs (based on bid-asked spreads and commissions) misses a critical point:

I mean, for instance, “Flash Boys” itself quotes a lot of money managers complaining about high frequency trading. They at least perceive that they’re getting ripped off, and there are some studies that support this view.

It’s worth spending a minute to understand why this question doesn’t have an obvious answer. When you buy 100 shares of a liquid stock, you pay a $10 commission and buy at (or below) the displayed inside offer. When you buy 10,000 shares, though, you probably don’t get all of those shares at the displayed offer. Maybe you get 1,000 at the offer, and then all of a sudden all the displayed bids and offers move up, and you end up paying an extra 10 cents for the other 9,900 shares. Here some obvious first-order measures of trading cost (bid/offer spread) suggest that your costs are low, but the fact that the market moves so quickly makes your actual cost high. But, of course: If the market makers couldn’t move so quickly, they’d have displayed a wider quote to begin with. So it’s hard to know whether you’re ahead or behind, on net.

In other words, the sort of analysis White invokes appears to miss completely the price change issue. Now perhaps her Penelope 2.0*** studies will get at that, but I wonder how one could even construct good proxies, let alone ones that will stand up to industry efforts to pull them apart.

White is thus playing true to a pattern all too familiar among financial regulators: make sufficient noise about a problem so as to appear to be doing something, but take a generally Panglossian view of the current system and focus only on a few undeniable warts to as to appease critics. Whether this stance is the result of intellectual capture, soft corruption, lack of courage, or lack of imagination is moot. The industry-accommodating results are pretty much the same.

* On this point, I agree with Felix Salmon: Lewis is all wet as far as retail stock traders are concerned.
** Sadly, as much as Schneiderman typically comes out on the right side of issues, he’s all hat, no cattle, in terms of doing anything about them.
*** As in the delaying tactics of Odysseus’ wife.

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  1. John

    That is how Democrats and their machinery work these days. Act and talk like you are (faux) progressive, especially just before an election, but behind the scenes you do all you can to side with Wall Street at Main Street expense. Yes, it is an all too familiar pattern. Regulators are part and parcel the party establishment and they add depth and breadth to the revolving door.

    1. James Levy

      I don’t think the Democratic Party elite believe they have another card to play. It’s software, movies, and FIRE: those are the cards they think America has to play, along with agriculture, weapons and the extractive industries, but those sectors ARE the Republican Party, so that’s that. These people are playing a global game and we are worried about local conditions and the plight of our neighbors and fellow citizens–those members of the Power Elite who label themselves Democrats are not. As George Carlin said, they threw us over 35 years ago when American dominance was no longer the natural outgrowth of World War II but suddenly had to be fought for. We were sacrificed in the project to “keep America on top.” To stay on top we need to dominate key sectors of the global economy. We have popular culture, computer software, finance, and insurance. They are going to fight to keep them if it kills us. And it is.

      1. Calgacus

        they threw us over 35 years ago when American dominance was no longer the natural outgrowth of World War II but suddenly had to be fought for. We were sacrificed in the project to “keep America on top.”

        Not at all. This is misidentifying the enemy. We were sacrificed in their project to keep them, their America of an economic royalism they saw threatened, on top. If the USA had maintained its postwar policies, or better became more Keynesian, had a JG, and the rest of the “advanced” world behaved as self-destructively as it did, the USA would be more on top now than it was then, than it is now. Even the reversal back then of the USA becoming more Keynesian than Europe when it had been less Keynesian during the postwar era was enough for the European economy to shrink relative to the USA over the past 30-40 years.

        1. James Levy

          I think when I used the term “they” I was pretty clear that I mean the Power Elite, not the vast majority of Americans. Whether or not they were stupid in the strategy they adopted, it was still built around dominating a few key sectors of the global economy, and the elite were happy to sacrifice the well-being of the many for that purpose.

        2. Calgacus

          I understand that. But I’m not saying that they were stupid. For their own goals, they probably did the correct thing. But both the “natural outgrowth” & “project” parts were wrong imho. I am saying that you still mistake their aim, their purpose, their project. “Throwing us over” was not a tactic toward the “global dominance” goal. It was the other way around.
          “Our” elite’s lust for global dominance (over other peoples & elites) is not what is killing us. Their determination to kill us and our learned ignorance of this is what is killing us. Simone Weil had it right with her “our brothers’ enemy” quote.

    2. NotTimothyGeithner

      The worst part is they believe they are progressive. Politico has a Rahm Emmanuel puff piece about how Versailles loves Rahm and idiots in areas with electoral college votes despise the mayor. What I found interesting is Rahm’s reputation for getting things done in DC, but there is no list of accomplishments* or example of Rahm gettin’ stuff dun!. Rahm ran the ’94 and ’10 Democratic National strategies, and he fought Dean over candidates in 2006 ultimately Rahm’s triangulators lost Kerry/Gore districts while Dean candidates won Bush districts. This is where Dems picked up seats in 2008 when Rahm wasn’t offering his insipid advice. Certainly he is a world class social climber, but the Village Dims clearly suffer from cognitive dissonance.

      *To be fair, Politico had a lengthy piece on Hillary’s run for Pres. In 2007/2008 and didn’t once mention Iraq, so…

      1. James Levy

        It’s creepy the extent to which what gets you places too often play-acting and perception. Jaime Dimon has fucked up time after time, but is bullet-proof. Rahm is the same. And Geithner is auditioning for his role as Treasury Secretary under Hillary. I’m always hearing about what a genius Larry Summers is, but have never heard anyone give an example of a brilliant thing he has said/done. But he acts the part real well!

        It seems if you wear the right kind of suit, strike the right kind of pose, went to the right kind of school, and made the right friends while you were there you can simply swagger your way to the top. Scheming beats accomplishing every time.

        1. OpenThePodBayDoorsHAL

          My colon clenched with your mention of Hilary/Timmy. What an incredibly pathetic state of affairs that in the midst of class warfare, theft, and stupidity on such an epic scale the body politic cannot do anything except sleepwalk into more business-as-usual corporo-fascism a la Hilary. In my generation we stopped a war, threw out a crook president, and completely changed the face of society. Are we so pumped through with Viagra and Prozac that sleepwalking to our doom is such a foregone conclusion?

      2. Yves Smith Post author

        Rahm was very effective in crushing the left. Google “Jane Hamsher” and “veal pen”.
        But no one wants to put that on a list of official accomplishments.

  2. Lafayette

    Frankly, I am surprised that the newly formed Consumer Financial Protection Bureau (created by the Dodd-Frank Act) seems to have nothing to say in the matter of Hi-Frequency trading.

    Maybe the Bureau feels that ordinary traders are not disadvantaged vis-a-vis the BigTraders?

    Strange …

    1. NotTimothyGeithner

      Small or individual traders probably don’t have much to fear as they are too small for the machines to recognize a pattern. It’s likely not worth the effort as they are often the sort who buy at the top anyway. Chuck Schwab clients are at the greatest risk. As for the CFPB, it’s largely a distraction from the failures or complicity of existing regulatory institutions. Admittedly, the institutional rot is so great that shutting the SEC down and turning the power over to a new agency such as the CFPB might make sense. Beyond the Warren cult of personality, the CFPB is another blue ribbon commission to provide electeds cover for inaction when confronted at town halls. Discussions of institutional degradation and Congress passing the buck get lost in overly complicated alphabet sludge.

    2. RUKidding

      Aren’t the “average investors” disadvantaged by Hi-Frequency crooked trading practices due to either personal investments in Mutual Funds and/or Pension funds? I’m not quite clear on that, and so, I could be wrong. But it seems like it’s possible that HFTs might deleterious affect the small fry investors in various funds. I’m not knowledgeable enough to know for sure.

    3. GuyFawkesLives

      Why would the CFPB have anything to say? The CFPB is yet another govt agency that does NOTHING! Homeowners have been providing the CFPB with CLEAR evidence of fraud in foreclosure……and the CFPB does absolutely nothing, so why would anyone think they would challenge the SEC? That’s a laugh. Thanks for the belly laugh this morning.

  3. John Mc

    Several things come to mind:

    1) CFPB has enough fraud, and predation work to do for years to come in what is the wild, wild west of neoliberal finance

    2) What makes us believe that the CFPB is immune to look-away or corrupting influences

    3) Not sure the CFPB has much jurisdiction over this part of the marketplace

    *** would be curious to see what others thought on this (at least others with more information and cynicism than myself).

    1. down2long

      I filed a complaind with the CFPB re Wells Fargo refusing my court ordered payments for five years. Two years ago, same situation with Ocwen, and I filed with the OCC. Must say the CFPB was on it, and I got prompt responses from them, and even Wells withdrew the pending foreclosure with the dawning information that the loan really is subject to bankruptcy law (who could’ve known, with the blizzard of lawyer letters and stuff I’ve sent since the plan was approved in 2009.) Must say the CFPB seems more effective and commands more respect from the banks. I filed OCC complaints about Ocwen/Deutsche Bank and Chase with the OCC. Deutsche did do some follow up, and called me. I still had to sue Ocwen. Chase thumbed its nose. It could be a result of a multitude of lawsuits, or who knows, but the CFPB does appear to have more clout.

      On a side note, just yesterday Wells had MERS put the title an actual company’s name. This is the second time they have done this since 2011. (Which makes me wonder why the title holder from the 2011 transfer was not the party to register title rather than MERS, which was supposedly subsumed in the 2011 transfer.) Not sure what it means, but that title is cloudy. Getting ready to lawyer up.

  4. c1ue

    Really, why is any of this surprising?
    All you need to do is look at what failed presidential candidates used to do: they would fade into the background. Some remained Senators, but they all essentially disappeared off the US national and international stage.
    Today – failed US presidential candidates become Secretary of State. Then go back to run again.
    Between that, and having a literal father and son Presidential pair (with a 2nd son not off the table), I fail to see how anyone can say the US is any form of democracy – as opposed to the reality of it being an oligarchy.
    And under an oligarchy – the role of the bureaucrat is to serve the oligarchy’s interests.
    Mdme. White is a good bureaucrat – she stays bought.

  5. Deaf Smith County

    The highlight of this essay is the sentence following “code is law”; how do political appointees, or courts, regulate technology that they don’t understand, despite endless briefings and testimony from advisors and consultants. After obligatory head nodding, pretending to understand, their conclusion is you can’t stop progress; time to modernize the rules. Homo sapien economicus the toolmaker is now ruled by the tools and those who know how to use them. Life is evolving into being “nasty, brutish, and complicated.”

  6. craazyboy

    //Robot Trading Program

    boolean bNewsHappy;
    boolean ReadNewsHeadlines(string sNewsFeeds);
    void SellSellSell(unsigned long lBigNumber);
    void BuyBuyBuy(long lBorrowedMoney );

    void main(){


    switch (bNewsHappy){
    case false:
    SellSellSell(unsigned long lBigNumber);
    BuyBuyBuy(long lBorrowedMoney );

    boolean ReadNewsHeadlines(string sNewsFeeds){
    if (sNewsFeeds.Contains(“Yellen”))
    return true;
    return false;
    return true;


    1. craazyboy

      opps. syntax error
      switch (bNewsHappy){
      case false:
      SellSellSell( lBigNumber);
      BuyBuyBuy( lBorrowedMoney );

      My Visual Studio editor would have caught that for me. Then really, we should do an OOP version. Maybe do a robo class so we can have an unlimited supply of robo objects. Then a SEC class and create a Robocop object that sits in memory eating donuts.

  7. Jackrabbit

    To hell with the optics. Must. Protect. Profit. Centers.

    – skimming (HFT)

    – loansharking (payday loans)

    – gaming (derivatives)

    – prostitution (revolving door)

    – protection racket (TBTF)

    – moneylaundering (moneylaundering)

    – counterfeiting (QE)

    Have a nice day!

    1. Jackrabbit

      Now, in the interest of fairness, each of these has its ‘reason to exist’ and defenders. But each is subject to abuse. Maybe with proper regulation, each could be socially useful. But regulation never seems to be sufficient.

      Researchers and Journalists usually focus on a specific business line. But when anyone with some understanding looks at the whole picture, its clear that regulation is inadequate, and that it is is almost certainly deliberately so.

      Time and time again we see scandal and injustice that is exlpained away a ‘bad apples’, or is answered by a lame: “we will look into it”. That DOESN’T mean that people forgive or forget what has happened – and the ‘system’ just gets more and more fragile. This fragility, however, goes unnoticed due to the nature of complex systems. But if (some would say when!) it all comes down, it is very likely to be NOT some terrible event but some minor straw – that nobody saw coming.

  8. redleg

    “All of these market quality metrics show that the current market structure is not fundamentally broken, let alone rigged. To the contrary, the equity markets are strong and generally continue to serve well the interests of both retail and institutional investors. ” -MJW
    If your worldview doesn’t include non-billionaires and megacorps, this makes perfect sense. Retail = Hedge Funds and Institutional = megabanks so everything is working perfectly.

  9. curlydan

    And it’s today that the SEC celebrates their 80th year with the big story on their website titled “We are the Investor’s Advocate Since June 6th, 1934”. I said, “What?!?” Maybe the 0.1% investor. I clicked on the related story, hoping for a comments section to unload, but no luck.

  10. scraping_by

    Ms White stumbles right out of the gate on this one.

    “First, we must evaluate all issues through the prism of the best interest of investors and the facilitation of capital formation for public companies. The secondary markets exist for investors and public companies, and their interests must be paramount.”

    This is almost word-for-word from Harvey Pitt, Bush II’s first SEC head, when he pronounced the SEC a service agency for corporations. It blandly ignores the best interests of the wider public. Seen though that prism, it’s not a closed binary system. It’s part of the economy, not all of it.

    The SEC needs to be a law enforcement agency, representing the rest of us in a strange little subsociety. A Pitt II regime isn’t going to cut it.

    1. bh2

      Oh, yes. Just what we need — yet another federal police force in SWAT gear with assault weapons at the ready. No doubt, like the DHS and BLM, the SEC would suddenly discover a vital need for millions of rounds of AR ammo to stockpile “just in case”.

      1. Big Daddy Warbucks

        I wold kind of like to see SEC cops SWAT’ed up, storming the Bankster citadels and perp walking out the Bespoken. It would make compelling TV, raise the morale of the 99%, and perhaps demonstrate money has not totally defanged law and regulation.

  11. TheCatSaid

    Even though it’s no surprise it’s still helpful to have this spelled out with such clarity.

    While generally speaking I consider transparency of great importance, it is discouraging to see “disclosure” used as a tactic to obfuscate, creating piles of details that make it less likely there will be meaningful scrutiny, and using “disclosure” as a way to pretend to be doing something valiant, while actually doing nothing that would create a fairer, more even playing field.

  12. bh2

    “she clearly does not intend to do much”

    Likely someone very important took her aside and offered a quiet word about possible consequences of getting in the way of powerful people who are permanently vested with an exclusive license to flagrantly strip-mine the citizenry. Nobody wants to be road-kill. Simple as that. No reason to believe it will be different this time.

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