Letter to Mary Schapiro Chairman United States Securities and Exchange Commission

Letter

U.S. Senator Charles E. Schumer (D-NY) today urged the Securities and Exchange Commission to consider new rules to "slow down" high-frequency trading (HFT) during periods of high market volatility, and proposed curbs on particular techniques--such as "quote stuffing" and sub-penny pricing--that are used by these traders and may have contributed to the flash crash last May.

"While I acknowledge that technological advances, including HFT, have brought significant efficiency gains to our markets, I have come to believe that HFT provides less of the benefits to our markets than its adherents claim, and does so at greater cost to long-term investors," Schumer wrote in a letter to SEC Chairman Mary Schapiro.

In calling for new rules to slow trading when necessary, Schumer said a system of speed bumps could slacken the pace of trading activity without resorting to the triggering of circuit breakers that would shut it down entirely.

Schumer then went further, proposing that the SEC place limits on two particular practices. To curb "quote stuffing"--which occurs when traders bombard the market with thousands of orders for only a split second before cancelling them--Schumer proposed that the agency require a minimum duration for any quote. Schumer also suggested the SEC should consider an outright ban on quotes in increments of less than a penny.

The letter was Schumer's second in as many months confronting high-frequency trading. In August, Schumer urged the SEC to place certain HFT firms under a uniform set of rules to prevent them from pulling out of markets en masse as they did during the May 6 flash crash. Schumer said updating the agency's 17-year-old "market maker" definition so that more of these traders had affirmative obligations when it comes to providing liquidity could go a long way towards preventing future volatility in stock prices.

A copy of Schumer's new letter to Schapiro appears below.

September 7, 2010

Mary Schapiro

Chairman

United States Securities and Exchange Commission

100 F Street, NE

Washington, DC 20549

Dear Chairman Schapiro,

I write out of concern about the increasingly significant role played in our equity markets by so-called "high frequency trading" (HFT), and the impact certain practices engaged in by HFT firms are having on the integrity of the market. In particular, recent news reports have highlighted the ways in which certain high-frequency traders place thousands of orders within a fraction of a second, then cancel those orders almost immediately.

While I acknowledge that technological advances, including HFT, have brought significant efficiency gains to our markets, I have come to believe that HFT provides less of the benefits to our markets than its adherents claim, and does so at greater cost to long-term investors.

High-frequency traders claim that they benefit the markets by providing significant additional liquidity, and to some extent that is true: HFT now accounts for roughly two-thirds of trading volume in our equities markets. But, according to recent reports, much of the supposed liquidity is not real -- when thousands of orders are sent and cancelled in a fraction of a second, it is clear that those orders were never intended to be executed. And some studies have shown that as little as 1% of orders posted are actually executed -- the rest are cancelled.

As a senior Member of the Senate Banking Committee, I ask the Commission to reconsider the role that HFT plays in our markets, and take action to protect the interests of long-term investors. Last month, I requested that the Commission consider increasing the affirmative obligations of high-frequency traders who are de facto market makers, so the liquidity they provide in "normal" markets doesn't disappear exactly when it's needed most. I now respectfully urge the Commission to also consider the following proposals.

First, the Commission should undertake a formal investigation of the related practices of "quote stuffing" and "sub-penny pricing" to determine what, if any, role they played in the May 6 Flash Crash. The SEC should also identify market participants who frequently engage in these practices, and require exchanges and other trading venues to slow down those market participants -- or even the whole market -- when they detect high and increasing levels of volatility or stress in the markets. This would complement the individual stock circuit breakers recently put in place by the Commission, and reduce the likelihood that such drastic steps would be necessary. It would be analogous to requiring markets to operate under a "yellow flag", rather than calling a time out by triggering the circuit breakers.

Second, the Commission should consider imposing a minimum quote duration, so that orders could not be sent and cancelled within a fraction of a second. This would increase the likelihood that any order would be executed, thereby incentivizing traders to refrain from sending thousands of orders they never intend to be executed.

Finally, the Commission should consider banning "sub-penny pricing", in which several orders are placed in price increments as small as one tenth of a cent. As recent news reports indicate, this practice may have contributed to market volatility on May 6, by creating the impression that there was far more trading volume in certain stocks that there actually was.

I recognize that there may be benefits to some of these practices. But the fundamental purpose of our equity markets is to allocate capital to productive businesses, and I am increasingly convinced that the costs of reducing execution speeds by an extra microsecond here or there outweigh the benefits in terms of allocating capital efficiently. The May 6 Flash Crash was just the latest reminder that the high-tech, high-speed games being played in our markets have undermined the ability of those overseeing the markets to ensure they remain fair, safe and sound.

I applaud the hard work you and your staff have done on these and related issues and greatly appreciate your consideration of the proposals discussed above. I look forward to continuing to work with you and your staff to address critical issues in our ever-evolving financial markets.

Sincerely,

Charles Schumer

United States Senator

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