Yesterday, the SEC approved a new rule called the “large trader” reporting rule. According to the SEC, the rule has two primary components:

– First, it requires large traders to register with the Commission through a new form, Form 13H.

– Second, it imposes recordkeeping, reporting, and limited monitoring requirements on certain registered broker-dealers through whom large traders execute their transactions.

A large trader will be defined as a person whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month.

While we don’t object to this rule, we also think that it is yet just another ‘band aid’ fix on our broken equity market structure. To fully analyze and understand what is going on in the market, the SEC still needs a consolidated audit trail which they have proposed but have still yet to approve. This would allow them to instantaneously analyze any market situation. While the large trader rule may help in a post-mortem analysis of a situation like the flash crash, the consolidated audit trail will provide immediate analysis that could possibly prevent a major problem even before it occurs.

The SEC has announced a number of ‘band aid’ fixes since the May 6th flash crash including the sponsored access rule, single stock circuit breakers, new rules on erroneous trades, the prohibition of stub quotes and now the large trader rule. All of these fixes address specific issues but none of them gets to the real problem that exist in our equity market – fragmentation. Multiple exchanges and multiple dark pools each quoting at different prices to comprise a National Best Bid and Offer sounds like a good idea. It sounds like it would be a model which would encourage innovation and lower costs. But what it really has done is just encourage high frequency traders to ‘arbitrage’ the slow SIP feed against their high speed, colocated private data feeds. These HFT traders have come to dominate the market with their fleeting liquidity. As Andrew Haldane from the Bank of England said, HFT “adds liquidity during a monsoon and absorbs it during a drought”. HFT traders are now the dominant force in the equity market and thus have the power to set prices. Their “liquidity”, not the liquidity of traditional institutional and retail investors, now drives the prices of major stocks and major indexes.

While we applaud the SEC for taking steps to address the Franken-Market that they helped create with various regulations over the past decade, we also wonder if this band aid approach is the best way to address the problems in the equity market. We wonder if these isolated “fixes” are the best way to spend their constrained resources or maybe a new approach which starts from scratch is a better idea.