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Joe Saluzzi
Joe Saluzzi
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The Stock Market Needs A Hockey Enforcer

Due to the pendulum shift to almost full automation and the massive fragmentation of the stock market over the past decade, our equity market currently lacks a self-policing mechanism.

Last week, The Wall Street Journal published an op-ed written by an assistant professor from the University of Alaska titled "Regulator, Go Slow on Reining in High Speed Trading" (registration required). The piece was a warning for regulators not to intervene and try to slow down the high frequency traders.

From the WSJ:

Attempts to regulate the speed or type of information in the market may distort markets. For example, high-speed trading has reduced bid-ask spreads, reducing trading costs for investors while increasing market efficiency...Attempts to regulate the speed of markets may create distortions that reduce the efficiency of markets in our high-velocity information world.

The op-ed was trying to take a free market approach to the problem of high frequency trading:

"New competitors will continue to enter a market until profits approach zero, and that is what appears to be happening in high-speed trading. The increased number of these traders has sped up the velocity of the market for everyone, making it increasingly difficult to take advantage of microsecond gaps in trading."

As Americans, we believe in capitalism and free markets but there are some areas of our economy that need to be regulated. Would you feel safe flying in an airplane if the FAA did not constantly police the airlines? Even professional sports require rules and regulations to keep the games fair and safe. The stock market is another critical area of the economy which requires rules and regulations.

There are some that believe markets are self-correcting and that regulators should follow the "do no harm" approach. We agree that sometimes regulations end up creating more damage than what they were trying to fix (for example, Regulation NMS). But we also believe that if left unchecked, some market participants, namely the for-profit stock exchanges and the high frequency trading community, will put their own short term profit motives ahead of the overall good of the market. Regulators have traditionally relied on the stock exchanges to police the markets but lately stock exchanges have been acting and behaving more like brokers.

[For more on a stock exchange's role in the modern markets, read: Are Exchange System Errors the New Normal in High Speed Markets?.]

Due to the pendulum shift to almost full automation and the massive fragmentation of the stock market over the past decade, our equity market currently lacks a self-policing mechanism. This mechanism existed for years in the stock market and helped protect the integrity of the market while rooting out bad players. Self-policing exists in many aspects of our life. Take professional hockey. Each team has an enforcer. If you take an illegal shot at a team's top player, then expect their enforcer to come after you on your next shift. No illegal shot goes unpunished.

Until the stock market can bring back its enforcers and start to self-police again, it will be up to the regulators to step up their surveillance and enforcement activities.

Joseph Saluzzi is partner, co-founder and co-head of equity trading of Themis Trading LLC, a leading independent agency brokerage firm that trades equities for institutional money managers and hedge funds. He is also the co-author of Broken Markets -- How High Frequency ... View Full Bio
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User Rank: Author
2/20/2013 | 6:04:00 PM
re: The Stock Market Needs A Hockey Enforcer
NJ_trader, By no means are we advocating self-policing as the only source of regulation. The problem that we face in today's market is that the amount of data has overwhelmed our regulators ability to properly police the market. However, we are encouraged with the SEC's new MIDAS system and their plans for a Consolidated Audit Trail (even if it only includes stocks and options). It's time for them to step up their game.
User Rank: Apprentice
2/19/2013 | 8:40:08 PM
re: The Stock Market Needs A Hockey Enforcer
I agree with many of your points but I strongly disagree that traders, whether they be individuals or highly-automated firms, putting "their own short term profit motives ahead of the overall good of the market" is a bad thing. We can argue about whether or not quote stuffing, pre-market index positioning, "spoofing", maker/taker pricing or other practices should be abolished, curtailed, or monitored but we should abstain from language that elevates the market over the individual.
You might have noticed that I didn't mention self-policing by the exchanges: that is something that needs to be examined. After all, the market making side of the business has changed so it's probably a good idea to take a look at how the regulatory side is handled as well.
User Rank: Moderator
2/19/2013 | 4:36:10 PM
re: The Stock Market Needs A Hockey Enforcer
Self policing has only limited success. It is really a utopian bankers dream to say "hey, don't worry, we're policing our own markets." It has failed in the past, so why will it succeed now? There's a reason why we have the SEC, FINRA, OCC and all the other alphabet soup regulators.

The way the markets are structured now, self regulation is a pipe dream. Remember, Wall Street is the nexus of capitalism. Profits > fairness. Profits > investor confidence. Profits > TBTF
Nathan Golia
Nathan Golia,
User Rank: Author
2/19/2013 | 3:35:56 PM
re: The Stock Market Needs A Hockey Enforcer
I think it's important to have a balance between self-policing and external regulation. Self-policing can sometimes end up with back-and-forth grudge matches G for example, the Steve Moore-Todd Bertuzzi incident from a few years ago. Even though Moore fought another Vancouver player after his transgression towards the Canucks' captain Naslund, he still ended up getting KO'd by Bertuzzi G and the resulting outrage threatened the vitality of the league. The NHL was forced to adopt tougher standards for hits in order to get problem players out of the league for a longer period of time G for example, the massive penalties assessed to players like Raffi Torres and Matt Cooke have led to those players taking steps to change their games and not face either on-ice or off-ice wrath. Similarly, financial markets regulators would benefit from acting swiftly to identify and remove problem actors early and mitigate the temptation for overreaction on the part of other players in the market, who could respond emotionally and cause more damage to the reputation of markets overall.
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