“We are the investor’s advocate.”
Mary L. Schapiro, head of the S.E.C., said traditional obligations among traders had fallen by the wayside.
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— William O. Douglas, chairman of the Securities and Exchange Commission, 1937
We ask regulators to make things better. Or at least not to make them worse.
But over the last decade, the Securities and Exchange Commission failed badly when it came to requiring stock markets to treat individual investors fairly. Markets that worked for such investors were replaced by ones that could not care less about them.
As Mary L. Schapiro, the S.E.C. chairman, put it, in the old system “the market participants with the best access to the markets” — New York Stock Exchange specialists and Nasdaq market makers — “were subject to significant trading obligations that were designed to promote fair and orderly markets and fair treatment of investors.”
“These traditional obligations,” she added in a speech to the Economic Club of New York this month, “have fallen by the wayside.”
The S.E.C. stood by as newer electronic markets evolved and came to dominate trading. The traders with the best access now have few if any obligations to investors.
Most of the time the new structure works well. But when it does not, individual investors can be the losers because markets cheat them in ways that would have been unthinkable — and probably illegal — only a few years ago.
Now the commission is trying to recover. This week the nation’s stock markets proposed new rules — rules that were agreed to after heavy pressure from the S.E.C. — to force market makers to stop posting ridiculous “stub” quotes. These days, such quotes are put up by market makers that are required to post quotes but do not really want to buy or sell shares. Those rules will do a little. But not much.
No longer will a market maker for a $100 stock be able to post a bid of one cent and an asked price of $1,000, as has become common and led to the spectacle of Accenture trading for one penny on May 6, the day of the “flash crash.”
But market makers will still be able to post quotes that are clearly intended to avoid making a market. If that stock is not issued by a major company, the posted quote could be $70 bid, $130 asked. For companies in the Russell 1,000 — the largest companies in the United States by market value — the quote would have to be narrower, within 8 percent of the market price. That works into $92 bid, $108 asked.
And the quote can be for only 100 shares.
There are two principal advantages to being a registered market maker on an exchange. The first is that capital requirements are eased. The second is that such firms can avoid buy-ins — where they are forced to buy stock that they did not deliver when they sold it — for a few days longer than other firms.
There are no real obligations for the role, however, at least in some markets. Instead, it is assumed that liquidity will be provided by traders with fast computers. Most of the time it is. But those traders can withdraw from the market whenever they choose to do so.
They did that on May 6. For some stocks, the only bid left was a stub quote of one cent, and the computers executed at that price. The sellers were unfortunates who had put in orders to sell at the market price — assuming wrongly that the market would function. Other losers were those who had put in stop-loss orders to sell if a stock fell below a specified price.
In the aftermath, officials canceled trades made at prices at least 60 percent below the previous day’s closing price. But if you sold for half what the share was worth in a real market, you were out of luck.
No such trades happened at the New York Stock Exchange, which had rules to slow down trading and let someone with a brain look first when trading got out of hand. Much of Wall Street wanted the S.E.C. to penalize the Big Board for slowing things down, which they thought was unconscionable in a modern world where trades should be executed within milliseconds of being sent to a market.
The exchanges have new rules aimed at providing more certainty about which trades would be canceled if another flash crash occurs. But in some cases, there is still no way to be sure. And any such rules have to be arbitrary.
There are more rules coming. Ms. Schapiro, in a speech to stock traders in New York this week, said the commission was considering requiring the so-called high frequency traders to take on obligations not unlike those that specialists used to have.
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