Walter Seeks SEC Rule Requiring Exchanges to Test Technology

Exchanges and clearing firms would have to routinely test their technology for stability and security under a rule being drafted by the U.S. Securities and Exchange Commission.

SEC Chairman Elisse B. Walter told an audience at American University’s Washington College of Law today that the agency has accelerated a proposal for a mandatory technology-review program. It would require market participants, including exchanges, clearing firms and other trading platforms, to test how their systems respond to outages and notify the agency about any disruptions.

The rule would convert a voluntary program, known as Automation Review Policy, that was created after the Oct. 16, 1987, market crash known as “Black Monday.” Under that program, exchanges voluntarily follow SEC guidance and submit to periodic SEC inspections of their systems.

“A voluntary standard is no substitute for a mandate and a requirement that you must follow,” Walter told reporters after the speech. She declined to say when the SEC might release a rule proposal for public comment.

Walter’s speech surveyed the SEC’s efforts to improve its technology in an era of high-frequency traders and electronic market makers. The commission’s Midas database and planned consolidated audit trail are key to that effort, she said.

Complex Plumbing

The consolidated audit trail will trace how orders are routed through the equity market’s complex plumbing. Midas will allow the commission to view all orders, order cancellations and trade executions on U.S. exchanges.

While the SEC has said the Midas data will help it reconstruct the causes of market crashes, Walter said today that it could also inform how new regulations are written.

SEC staff will likely use Midas to analyze the practice of offering quotes and then quickly canceling them. The exercise could provide a “clearer picture” about the impact of a potential rule requiring high-frequency traders to maintain a quote to buy or sell a security for a minimum amount of time, she said.

The commission is considering publicly releasing the studies it performs using Midas data, Walter said.

“Whatever the data reveals, the SEC will have a substantially deeper understanding of where and how we should and can act to make the markets more stable for investors,” she said during the speech.

The agency also is developing models to identify suspicious financial results in routine public filings. In addition, a new tool will electronically scope public companies’ written disclosures for irregularities, Walter said.

“Through this model we hope to be able to more quickly identify ‘earnings management’ -– which is a nice way of saying manipulative or even fraudulent accounting practices,” she said.

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