The Securities and Exchange Commission was severely constrained under President George W. Bush, who blamed slow economic growth on “SEC overreach”. The SEC has now lost its Cinderella status – but its new chairman, Mary Schapiro, must avoid giving credence to Mr Bush’s misconceived complaint.
Since the change of the guard at the White House, the SEC has locked horns with corporate giants, such as Bank of America, forced to settle a claim that it misled investors, and General Electric, humiliated by an SEC probe into its accounting practices.
Beyond showdowns with individual companies, Ms Schapiro has deployed the SEC’s long underused authority to regulate securities markets, casting her eye on high-speed trading made possible by new technology. High-frequency traders use fast computers to exploit tiny spreads and make money by trading large volumes.
Some complain that these practices harm “real” investors. That is possible. Speed makes it easier to use quick trades to divine other investors’ price limits and capture spreads. But this is hardly a public policy concern. Outsmarting the competition with the latest technology is as old as markets themselves. We do not worry that steamships stole the margins of sailing fleet operators.
Other practices are less innocuous. “Flash trading” (where orders are shown to members of an exchange for a split second before being passed on to the wider market) has come in for particular suspicion; Senator Charles Schumer wants Ms Schapiro to ban it, worrying that it allows privileged insiders to front-run smaller investors. If it does, it should be stopped. But the bar must be high for any ban on flash trading or crackdown on “dark pools” of non-public equity trades. Stronger reasons are needed to limit a right to private contract than that third parties do not get the same deal.
One justification is systemic stability; but unlike derivatives, non-public equity trades carry little risk for others beyond the traders themselves. Another is competition concerns. But exchanges use flash trading as an incentive to attract liquidity in a competition for customers, who can choose whether a platform’s tighter spreads or deeper order lists outweigh the risk of being gamed.
Ms Schapiro is rightly keen to restore the SEC’s power. She must fight for more resources to prevent market abuse, whether the mechanism is new or old. Bernard Madoff did not, after all, need split-second speed to evade the SEC for years.
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