Kaufman on High Frequency Trading

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In letter to SEC Chairman Schapiro, Senator outlines dangers of manipulative algorithms and systemic risk

November 20, 2009 -- WASHINGTON, DC – Senator Ted Kaufman (D-DE) today urged Securities and Exchange Commission (SEC) Chairman Mary Schapiro to take immediate steps to combat manipulative high frequency trading algorithms and end so-called “sponsored access,” which Kaufman and many market experts believe exposes the U.S. capital markets to systemic risk.

Sponsored access permits traders – many of which are unregulated hedge funds – to trade directly on an exchange, circumventing risk checks that apply to broker-dealer trades.

“While it is clear that high frequency trading brings certain benefits to our markets, it is also clear that manipulative high frequency algorithms are almost certainly operating today and that sponsored access creates a systemic risk today,” Kaufman wrote in a Nov. 20 letter delivered to Chairman Schapiro and the SEC’s four other commissioners.

Kaufman has been urging the SEC to look more closely at market structure issues since he wrote the Commission on Aug. 21 calling for a comprehensive “ground up” review before piecemeal changes in the existing structure only increase concerns about unfairness or systemic risk. Last month he was the lead witness in a Senate Banking subcommittee hearing on a host of market structure issues, including high frequency trading, which uses ultra-fast computers, co-located servers and proprietary data feeds direct from market centers to make thousands of trades a second.

“Given that the Commission under current procedures is now blind to high frequency operations, the need for immediate action should not wait until the Commission has completed its comprehensive review,” Kaufman wrote.

An attachment to Kaufman’s letter to Schapiro spells out in detail his thoughts on three areas where further Commission action is needed for market fairness: consolidated surveillance authority, dissemination of market data and modernizing best execution reporting standards. “Fairness,” Kaufman writes in his attachment, “may be an elusive and evolving concept in the securities market, but it must be defined and then vigorously defended by regulators.”

“[G]iven the current lack of effective market surveillance,” Kaufman writes, “we simply cannot permit high frequency practices to continue unchecked without the ability of regulators to observe and stop manipulation or to avert systemic risks.”

Source: Senator Ted Kaufman