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Ted Kaufman, still throwin punches.

http://www.nytimes.com/2011/05/06/opinion/06kaufman.html?ref=opinion

May 5, 2011
Preventing the Next Flash Crash By EDWARD E. KAUFMAN Jr. AND CARL M. LEVIN

ONE year ago, the stock market took a brief and terrifying nose-dive. Almost
a trillion dollars in wealth momentarily vanished. Shares in blue-chip
companies were traded at absurdly low
prices.<http://query.nytimes.com/gst/fullpage.html?res=9907E4DE1E31F934A35756C0A9669D8B63&pagewanted=1>High-frequency
traders, who use computers to look for microscopic price
differences in stocks on different exchanges and other trading venues,
stopped trading, while others immediately sold whatever they bought, mainly
to each other, in what has been called “hot potato” trading.

We haven’t had a repeat of last year’s “flash crash,” but algorithmic
trading has caused mini-flash crashes since, and surveys suggest that most
investors and analysts believe it’s only a matter of time before the Big
One.

They’re right to be afraid. The top cop for our financial markets remains
inexcusably blind to the activities of high-speed computer trading.

After the flash crash, the Securities and Exchange Commission moved quickly
to apply a Band-Aid in the form of circuit breakers to limit daily price
moves. Then it proposed a long-overdue consolidated audit trail, to plug
the gaps in reporting requirements that prevent the efficient tracking and
policing of orders and trades. It spent months painstakingly using
antiquated methods to reconstruct and study the trading data during the
flash crash. With the Commodity Futures Trading Commission, it convened a
joint advisory committee, which presented an array of
recommendations<http://www.sec.gov/spotlight/sec-cftcjointcommittee/021811-report.pdf>in
February. And it continued to dither.

The consequences of inaction are dire. If the average investor comes to
believe stocks are valued not on the basis of a company’s expected future
earnings but on the machinations of computers trading against other
computers for speed and advantage, our stock markets will have become a
casino.

The explosion in computer-based trading has occurred over the past decade as
the S.E.C. adopted rules that allowed dozens of new trading venues to
compete for stock orders and accelerated the move toward high-frequency
trading, which now accounts for 70 percent of daily stock-trading volume.

While competition has lowered trading costs and in some cases improved
efficiency, the result has been a confusing amalgam of more than 50
electronic trading networks, some of which are designed to hide large block
trades, and traditional exchanges, which are governed by outmoded
regulations that do not require full transparency. High-frequency traders
navigate this maze with ever more sophisticated technology — and armies of
computer and math specialists — to find and exploit slight price variations.


Yes, both volume and volatility in the equity markets have been declining in
recent months, but the centrality of high-frequency trading has not
diminished. Moreover, high-frequency traders have gone beyond trading stocks
to futures, options, bonds, currencies and other asset classes — and are
making incursions in foreign markets. The next flash crash could be more
pervasive than last year’s, as global asset markets become increasingly
correlated through the convergence of computer-driven trading strategies.

Why hasn’t the S.E.C. acted? Defenders would say that Congressionally
imposed deadlines for instituting the Dodd-Frank overhaul of financial
regulations have overwhelmed the commission and forced it to put changes to
the equity markets on the back burner.

But the paralysis at the S.E.C. runs much deeper. It’s been 20 years since
Congress gave it the authority to require large-volume traders to make more
detailed disclosures; 18 months since the commission’s chairman, Mary L.
Schapiro, said it would use that authority; 13 months since the
agency proposed a rule to do so; and three months since the advisory
committee recommended proceeding with “urgency” on the audit trail.

Meanwhile, even Ms. Schapiro has publicly expressed worry that our markets
no longer adequately perform their main functions: helping companies to
raise capital to innovate and grow and helping long-term investors to
contribute to the American economy while building a retirement nest egg.
Mutual fund outflows continued unabated after the flash crash through the
end of 2010, an indication that ordinary investors are fleeing the market.

In response, the S.E.C. should work with the C.F.T.C. to establish the audit
trail, which would allow real-time monitoring of electronic trading; stop
trading venues from catering unfairly to high-speed traders at the expense
of regular investors; make high-frequency traders bear their fair share of
the costs involved in heavy, instantaneous flow of electronic messages,
which would discourage strategies to stuff the system with orders that are
immediately canceled; and rethink rules that give too much priority to the
rapid-fire orders that high-frequency traders rely upon.

More is at stake than the confidence of small investors. A survey by the
consulting firm Grant Thornton shows that initial public offerings by small
companies have declined<http://www.grantthornton.com/staticfiles/GTCom/files/GT%20Thinking/IPO%20white%20paper/Why%20are%20IPOs%20in%20the%20ICU_11_19.pdf>over
the past 15 years. The profits to be made in supporting small-cap
stocks have dried up as Wall Street has focused obsessively on leverage and
high-volume trading.

One promising idea being floated is an experimental market, with rules
tailored to support the capitalization of the fastest-growing companies,
many of them start-ups that are drivers of job creation.

America’s capital markets, once the envy of the world, have been transformed
in the name of competition that was said to benefit investors. Instead, this
has produced an almost lawless high-speed maze where prices can spiral out
of control, spooking average investors and start-up entrepreneurs alike.

The flash crash should have sounded an alarm. Unfortunately, the regulators
are still asleep.

Edward E. Kaufman Jr. was a Democratic senator from Delaware from 2009 to
2010. Carl M. Levin, a Democratic senator from Michigan, is the chairman of
the Permanent Subcommittee on Investigations.


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Alexander Snyder-Mackler
(302) 598-867