SEC Cracks Down to Prevent Another ‘Flash Crash’
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By Herbert Lash and
Sarah N Lynch,
Reuters
January 16, 2012

The May 2010 "flash crash" was bad for almost everyone involved in the stock market, but for the Securities and Exchange Commission, it was a disaster. With $1 trillion in shareholder equity wiped out in a matter of minutes – however temporarily – alarmed investors demanded answers.

Embarrassingly, the heads of the New York Stock Exchange and Nasdaq Stock Market got into a spat on television, blaming each other for the mess, and the SEC realized that it didn't have the information to explain what caused the scariest few minutes in recent Wall Street history.

The regulators had to seek the data from the exchanges, delaying a much-anticipated report on the crash by nearly five months. The unwelcome lapse in oversight laid bare the SEC's limited ability to track the inner workings of the marketplace when it matters most.

"The idea that the regulator of the largest capital markets in the world cannot easily reconstruct trading when there has been a problem, or when there is a suspicion of manipulation or misconduct, is not acceptable to me," said SEC Chairman Mary Schapiro in an interview. "We have to have this capacity."

The unwelcome lapse in oversight laid bare the SEC's
limited ability to track the inner workings of
the marketplace when it matters most.

In response to the crash, Schapiro has ordered an SEC crackdown on the exchanges – the front-line for fighting structural flaws and abusive trading in equity markets – in order to oversee more actively a marketplace whose complexity masks serious risks for investors.

The crackdown has come in the form of enforcement actions and gag orders against exchanges. Regulators are moving ahead with a plan to put together a record of all market activity to better oversee trading, a massive undertaking given the volume and rapid-fire pace. Some say the SEC is pushing hard for high-profile actions to burnish its image after the flash crash and its failure to spot Bernard Madoff's Ponzi scheme.

It all points to a bigger government role. Regulators are now seeking a better grasp of high-tech markets that were allowed to fragment and proliferate over the last decade in the name of competition and lower costs. The SEC's actions suggest, at a minimum, that regulators believe the exchanges have not always honored their commitment to maintain stable markets.

Schapiro said the SEC's move to police the market more effectively was driven by the rise in computer-driven algorithmic trading as the dominant force in trading and the need to fully enlist the exchanges, which are self-regulatory organizations (SROs).

"We need to have very careful, thorough and rigorous oversight of SROs if we are going to rely on them to do front-line surveillance," Schapiro told Reuters. Given the lack of resources at the SEC and the explosion in trading, the SROs need to be "truly vigilant," she said.

The market absorbs hundreds of thousands of quotes every second in a frenzy that can befuddle investors and traders alike. While perhaps good for exchanges and high-frequency traders, the value of this explosive growth has been questioned.