Wall Street firms that gave high-frequency traders direct access to the equity markets and contributed to last May 6 “Flash Crash” could face sanctions from market regulator.
On May 6th the trading in stock market became highly volatile and within few minutes the Dow Jones Industrial Average fell nearly 1,000. At the time, many on Wall Street were at a loss for the violent swing in stock prices. However, later many blamed high-frequency trading firms.
The exchanges most affected by the flash crash were the New York Stock Exchange, which is operated by NYSE Euronext and the Nasdaq Stock Market, which is operated by Nasdaq OMX Group.
As the result, according to Financial Times, the Financial Industry Regulatory Association (FINRA) is undertaking a “sweep” of broker-dealers that offer market access to high-frequency traders to find out if they allowed these firms to run computerized trading programs – algorithms – without undertaking proper risk-management controls.
FINRA will try and determine whether the broker/dealers have the proper risk management controls in order to police clients that buy and sell securities quickly through computer driven algorithmic trades.
“We’re looking to find out if the brokers understood what was being done with the algorithm and whether the high-frequency trader had thought through how it would work under big market changes,” Richard Ketchum, chairman and chief executive of FINRA, told the Financial Times.
Brokers also face scrutiny of their checks on the ownership of the firms they allow – directly or through sponsorship arrangements – to access the markets.
“The brokers should be satisfied they know who’s really operating these systems,” Mr. Ketchum further told the Financial Times. “The sub-custodian chain can bury the identity of high-frequency traders in Eastern Europe and elsewhere who raise serious regulatory concerns.”
What it means to broker-dealers, there is about to be some changes in market structure as arguably more than half of the market “participants” are suddenly excluded from constant daily churning activity. What the outcome of this will be is anyone’s guess, but definitely expect strange things if this is truly a first step towards reverting to some form of normalcy.
The probe will at the very least lead to tougher guidelines. “You can expect something to come out of it,” Mr. Ketchum said. “Certainly, there may be enforcement actions if we find serious cases where brokers have failed to even try to exercise their obligations to run checks on the firms before allowing them access.”
Next month, the Securities and Exchange Commission and the Commodity Futures Trading Commission will come out with their own report on the flash crash.
