The Will and Way to Surveill
March 8, 2010
TO: Mary Schapiro, chairman, Securities and Exchange Commission; and, Gary Gensler, chairman, Commodities Futures Trading Commission
FROM: Aldo Martinez
RE: Surveillance of Markets in 2010 and Beyond
Whether government regulators or market centers or other self-regulatory organizations should conduct trading surveillance of our markets may not be the ultimate question.
Personally, I prefer that non-governmental entities perform market surveillance. Notwithstanding that, there is no question that public investors and American markets would be better off if your organizations possess the appropriate data and technology to massage that data. This way you can maintain confidence in markets, as you see fit, removed from any need to satisfy shareholder or customer interests.
What then is the data needed to protect the interests of investors and maintain confidence in our markets? And what technology is needed to effectively massage such data to efficiently detect violative conduct in our markets?
The technology sufficiently flexible to handle this challenge exists. However, if the definition of market integrity includes the absence of fraud and trading abuses, then the arsenal of government regulators or market centers or any other regulatory services provider also must have appropriately trained staff, relevant data and reasonable processes which, when working together, will maximize successful market surveillance and intervention, when needed.
Today's markets are increasingly fragmented, with a dozen equities, fixed-income, options, financial futures and derivative venues of different sorts operating at the speed of electrons. That fragmentation in North America makes it necessary to watch trading across multiple types of products on multiple markets at the same time. And even to watch trading across borders.
When no one equity or options market center has more than 34% market share in its listed issuers, no one market center enjoys the critical mass of trading information necessary to reliably conduct surveillance on market manipulation and stock-to-stock front-running.
In the U.S., government and market center regulators have established protocols for conducting cross-markets insider trading market surveillance for stock and options. However, more needs to be done in all areas with respect to cross-market and cross-product market manipulation and other trading abuses in stocks and options.
That means coming up with a single, consolidated and comprehensive database of trading and order information across all the venues, enhanced to provide account identification as well. Like the most advanced regulating agencies around the world, those in the U.S. need to know and be able to see who is trading what-as the trading takes place.
This does not mean associating trades with account owner names. But it does mean having unique identifiers for trading accounts. This permits accurate pattern analysis and tracking of activity across markets, to spot manipulation of prices in stock and options; front-running in stocks or options; insider-trading at the earliest stages; and other abuses.
The new era of electronic surveillance needs to be approached holistically. Not only have our markets changed but technology also presents a significant threat. Markets, too, are vulnerable to cyber attacks. We cannot turn our backs to that possibility and should respond, in advance, as if this is the markets' next lurking unthinkable event.
