Brokers win one, lose one in SEC votes

The Securities and Exchange Commission backed proposals today that would assign identification codes to monitor the largest stock traders and impose a limit on fees for options transactions.

Commissioners voted 5-0 in favor of a program that would require firms that buy and sell at least 2 million shares a day to report their identity to regulators. The rule would also apply to companies that execute $20 million of equities a day or $200 million in a month.

The SEC is evaluating whether strategies used at high- frequency trading firms and hedge funds are hurting markets by increasing volatility and making it more difficult for investors to complete transactions. Lawmakers such as U.S. Senator Ted Kaufman question whether companies that trade thousands of shares in milliseconds and account for more than 60 percent of U.S. volume hurt returns for long-term investors.

“This casts a wide net,” said Justin Schack, director for market structure analysis at Rosenblatt Securities Inc. “A lot of high-frequency trading firms will meet that threshold,” though it’s unclear if any agency has “the technological and intellectual capital to do anything meaningful with this data.”

About 400 of the biggest firms would have to use the codes, with their brokers maintaining records and providing data to the SEC. The proposal is designed to capture trading by any firm that accounts for one-hundredth of one percent of average daily trading volume, according to Robert Cook, director of the SEC’s division of trading and markets.

“Today’s proposed rules are necessary to keep pace with our ever-changing securities markets — markets that have undergone dynamic transformation in recent years,” SEC Chairman Mary Schapiro said in a statement. “The fact is that rapid technological advances have had an impact on trading strategies and on the ways in which some broker-dealers carry out their trades.” U.S. Representative Eric Cantor of Virginia, who has questioned efforts by Schapiro to increase regulation of exchange innovations and high-frequency traders, said he’s concerned that the SEC continues to propose rules without adequately studying the potential consequences for U.S. markets.

“The decisions coming from the commission need to be based on solid empirical data,” Cantor, the second-ranked House Republican, said in a statement today. “I remain concerned that the SEC is moving ad hoc in nature and not looking at these issues in a comprehensive and holistic manner.”

The SEC has faced “a lot of political pressure” to take action on high-frequency trading, said Schack, who is based in New York. “This could be a step to help ease some of that pressure and get a better handle on those trading strategies.”

Data would be available to the SEC the day after trades are made, allowing the agency to investigate manipulative and abusive practices, the agency said. Data won’t be made available to the public, according to the proposal. The SEC will seek comment on the plan before agency commissioners consider holding a second vote on it to make the requirements binding.

Commissioners also voted 5-0 to back a proposal capping fees for trading options at 30 cents a contract, a rule supported by brokerages who say getting the best bid or ask price for their customers sometimes costs too much.

Citadel Investment Group LLC petitioned in July 2008 to limit charges by exchanges to execute against orders on their books. SEC requirements that brokers buy and sell securities for clients at the best available quote in the marketplace may encourage venues to charge “excessive” fees to access their systems, masking the true cost of trading, it said.

“Brokers have to get the best quoted price, which is good,” said Andrew Kolinsky, president of Citadel’s market- making unit, before the SEC meeting. “If an exchange is allowed to charge unlimited access fees to get at the supposedly best price, then what’s disseminated as the best price is not really the best.”

Eight exchanges compete for business in the U.S. options market, where volume reached a record in 2009. The SEC under Schapiro has been studying ways of adding transparency to trading without hurting exchanges’ ability to tailor services for professionals, their biggest source of growth in revenue and market share.

Equity exchanges and some options platforms instituted fees and rebates in the last decade to attract brokerages whose traditional way of making money, capturing the spread between bid and ask quotes, was squeezed as price increments narrowed. The model, known as maker-taker pricing, rewards brokers and investors who put requests to buy and sell shares in an exchange’s book and charges those who execute against them.

International Securities Exchange Holdings Inc. spokeswoman Molly McGregor, Gail Osten of Chicago Board Options Exchange and NYSE Euronext’s Eric Ryan declined to comment before the SEC meeting. Nasdaq OMX Group Inc. spokesman Robert Madden didn’t respond directly to a request for comment about a cap on access fees. The ISE, NYSE and Nasdaq are based in New York.

NYSE Euronext asked the SEC in September 2008 to reject Chicago-based Citadel’s petition because it “fails to take into consideration the fee structures of all options exchanges,” including inducements called payment for order flow used on venues such as CBOE and ISE. Exchanges that offer these programs typically don’t charge customers for executions.

SEC Commissioner Elisse Walter said during the meeting that payment for order flow remains an “important issue.” She added that the SEC should explore “whether both maker-taker and payment-for-order-flow programs contribute to price distortions,” and should consider whether fee caps ought to be “accompanied by a comparable cap” on other incentives.