FINRA boss says brokers must monitor flash traders

By Joseph A. Giannone

BALTIMORE (BestGrowthStock) – As regulators sort through the fall-out of the “flash crash” that sent stocks reeling early this month, FINRA Chief Executive Richard Ketchum says it is clear broker-dealer firms must do a better job monitoring their direct-access trading customers.

U.S. regulators are still reconstructing the events of May 6, when the Dow Jones Industrial Average plunged nearly 1,000 points. The Securities and Exchange Commission and the Commodity Futures Trading Commission recently proposed rules to halt trading across exchanges, among other market structure changes.

Still Ketchum told Reuters a major part of any remedy is to force broker dealers to know what their rapid-trading clients are doing.

“Firms that provide direct access to customers, from the standpoint of either giving up their name for execution purposes or for clearing purposes, have a supervisory responsibility,” Ketchum said at the Financial Industry Regulatory Authority’s annual meeting in Baltimore.

The frightening, unexplained market rout was merely the latest episode of computer-driven trading systems running out of control. Regulators have known since the fall of 2008 that computer algorithms can continue to sell stocks down to a penny a share and have still not dealt with the problem, Ketchum said.

FINRA, which oversees Wall Street firms, says brokers need to take a more active role.

“We’re going to be asking a lot of hard questions of firms,” Ketchum said, on the sidelines of the conference.

“Did they understand the screens they were building or those systems they are providing direct access to? Why didn’t they look closer with respect to the ability for those systems to step back rather than continue to sell at prices that obviously were disadvantageous and which dramatically impacted the market?” he said.

FINRA is supporting the SEC and the CFTC as they piece together exactly what happened that day and find ways to prevent such an event from reoccurring.

Initially, regulators proposed system-wide trading pauses for members of the S&P 500 Index — the largest U.S. listed companies. That list will be expanded, he said.

“We’re working hard to identify the right way to expand the number of stocks and certainly to address ETFs, which were some of the more volatile products on that day,” he said.

Among the technical details that remain were how to handle the period between when an exchange concludes that trading in a stock should be paused, and the time other market participants are informed, he said. That will factor in on which trades should be canceled or completed.

Ketchum stressed there is no formal investigation, but regulators are trying to understand the day’s events. This process will have the broader benefit, he added, of helping regulators better watch markets going forward.

“We don’t know. Perhaps there was abusive trading here. What’s pretty clear is whatever the case, whether an erroneous trade — though that seems unlikely — whether there was some calculated trading that violated the rules in some way, or whether this was uncoordinated mass-panic across algorithms, it’s clearly shown the brittleness of the market structure and has shown we have to make changes,” he said.

As it stands, regulators cannot easily determine the forces behind millions of trades.

“We need to move the audit trail to the point where we have a much better handle on the people who are actively trading,” he said. “That’s not just important for reconstructing that day but also important for market surveillance.”

Earlier on Wednesday, the SEC proposed a consolidated audit trail for U.S. stocks (Read more about the stock market today. ) and listed options that would allow it to track orders across markets in real time.

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(Reporting by Joseph A. Giannone, editing by Leslie Gevirtz)

FINRA boss says brokers must monitor flash traders