SEC Prepares to Act on Sponsored Access
November 2, 2009
Securities and Exchange Commission Chairman Mary L. Schapiro told members of the Securities Industry and Financial Markets Association last week that it is preparing to deal directly with the practice of "sponsored access."
The move toward creating a set of SEC rules on the practice may require broker-dealers to make technology changes sooner rather than later.
Until a few months ago, the SEC appeared to be addressing sponsored access by considering a Nasdaq proposal to create an electronic gateway to monitor orders of sponsored clients before they are executed. Other exchanges are working on similar technology.
In sponsored access arrangements, broker-dealers lend their exchange IDs to clients-often non-broker-dealers-who then trade over the exchanges directly, without monitoring of their activity prior to a trade.
In several comment letters, Lime Brokerage has noted the recklessness of allowing sponsored access, especially in today's high-speed trading world where thousands of orders can be executed in less than a second.
Colorfully, Schapiro likened sponsored access to giving "car keys to a friend who doesn't have a license and letting the friend drive unaccompanied."
"I recognize some markets have been seeking to address this issue, but I also worry that competitive pressures could delay an effective solution-one that would apply across all markets to assure a level playing field for all investors," Schapiro said.
Wedbush Morgan and Penson Worldwide, two large sponsored-access providers, monitor activity immediately after the trade.
Lime has recommended to the SEC that sponsored access should be eliminated by requiring orders to pass through broker-dealers' trading systems.
John Jacobs, director of operations at Lime, said in an interview that current regulations already require checking orders for sales validation prior to placing them.
If SEC chooses to give sponsored access a "safe harbor," Lime, which caters to high-speed traders, says the exchanges and other market centers must implement "dynamic risk control mechanisms," allowing sponsoring broker-dealers to automatically turn off clients' trading.
Since sponsored clients trade directly over market centers, their sponsors now must either telephone the exchanges or go on to their websites to stop clients' problematic orders and trades.
Lime says broker-dealers must have systems to monitor client trades as well as orders-since high-frequency traders typically execute a small fraction of their orders. In addition, Lime says, sponsoring broker-dealers should demonstrate the ability to process and evaluate market centers' drop copies of order and trade messages in three milliseconds or less.
