In early 2010, the U.S. Securities and Exchange Commission (SEC) announced the imminence of a sweeping new rule preventing brokers from offering individual customers unfiltered market access to direct access trading. Those transactions of customers who use brokers' own passes to exchanges, as well as to alternative trading systems (ATS) offering non-exchange trading, will begin to be better regulated.
This popular method of trading, which is a form of sponsored or direct market access trading (DMA), will affect many online investors and traders: according to the SEC's January 13, 2010 press release, around the time of the announcement, a goodly 38% of U.S. equities trading occured through this "naked access" arrangement.
Update 11/3/2010: On November 3, 2010, the SEC voted in favor of Rule 15c3-5, which takes effect within 60 days of being published in the Federal Register and which grants 6 months beyond that point to comply with the rule. For background on this rule, read on.
What is Naked / Unfiltered Direct Access Trading?
The issue at hand is the ability of brokers to let customers use their MPID (market participant identifier code) to directly access, via a software platform, a trade network, such as a stock or futures exchange or a call market, ECN (electronic communication network) or other SEC-approved trading system, in order to get information or conduct transactions, a practice known as providing "naked" access or "unfiltered" access.
Although not necessarily less expensive for the trader, this kind of online trading platform is convenient and speeds the process along in an Internet investment environment where a few seconds' delay can make the difference - and thus has become very popular. However, direct market access systems vary wildly from each other in their accuracy, processing times and fees. Since so many kinds of SEC-regulated online trading transactions are affected, from NASDAQ stocks to commodities to futures, the SEC's watchful eye on such investment platforms will probably have a big effect on the world financial market.
SEC Seeks Risk Management Controls of Unfiltered DMA (Direct Market Access) Transactions
According to the SEC, allowing this unscreened market access by traders, who in using the software may make mistakes on orders and who are not necessarily subject to federal securities laws and self-regulatory organizations (as brokers themselves would be), effectively presents a means to finagle or bypass said laws and regulations.
Proposed are new requirements for broker-dealers that replace this type of use of direct market access trading systems. Broker-dealers can still allow a direct market access platform to traders under the new SEC rule. But once the new rule takes effect, it won't be "naked" or "unfiltered."
Brokers, themselves - no delegating to third parties allowed - must put both automatic and documented measures and controls in place to prevent certain problems with unregulated individuals placing orders, including:
- trading orders going beyond credit limits or capital thresholds
- catching problem orders before trading occurs (i.e., pre-trade)
- the failure of direct market access trading orders to comply with applicable financial regulations to which brokers are subject.
Goodbye, Unfiltered DAT: The Days of the Naked Direct Access Trading System Are Numbered
The SEC voted in early 2010 to prohibit brokers from letting exchange traders use their market participant identifier to allow unfiltered access to exchanges and other financial trading systems. Any access provided must be actively managed by the broker and risks of erroneous, unlawful or problematic trades controlled. The proposal asks for public comment to be submitted to the SEC within 60 days of its being published in the Federal Register.
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References:
Securities and Exchange Commission Press Release on Market Access Control of Unfiltered Access January 13, 2010
SEC Adopts New Rule Preventing Unfiltered Market Access, SEC Press Release, November 3, 2010
Kerry Bakerson - Kerry's fiction has been published by Mundania Press. A former jewelry designer and bookseller, Kerry is now a full-time web content ...
