FINRA Investigating Whether Broker-Dealers Providing Adequate Risk Controls to High-Frequency Traders

A Financial Industry Regulatory Authority says the SRO is investigating whether broker-dealers failed to put adequate risk-management controls in place for high-frequency traders with access to an exchange or alternative trading system. The probe comes following the flash crash last May that involved the stock markets dropping almost 1,000 points in a matter of minutes before rebounding just as quickly. While lawmakers said that high-frequency trading was to blame, the Commodity Futures Trading Commission and Securities and Exchange Commission disagree.

FINRA says that Chief Executive Officer Richard Ketchum’s concern is whether brokers had full comprehension of how the traders were using algorithms and whether the latter understood the possible consequences during times of serious volatility. Ketchum vowed that if serious cases of brokers failing to “even try to exercise their obligations to run checks on the firms” prior to giving them access are uncovered, then enforcement actions will be taken.

Meantime, the Securities and Exchange Commission is considering a pending rule proposal on unfiltered or naked access arrangements that would allow high-frequency traders to completely bypass risk management controls set up by broker-dealers.

High-Frequency Trading
High-frequency trading depends on computer algorithms (rather than human action) to execute transactions at super fast speed. High-frequency traders are usually institutional investors, such as pension funds or mutual funds. Through broker-dealers, these traders are able to gain direct electronic access to an exchange or ATS. According to recent data, high-frequency trading now makes up over 70% of market volume.

Related Web Resources:
High Frequency Trading and the Roiling Markets, Newsweek, June 1, 2010

High-frequency traders in the cross hairs after stock market’s wild day, LA TImes, May 6, 2010


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