Securities and Exchange Commission
Good morning. This is an open meeting of the U.S. Securities and Exchange Commission on March 7, 2013.
Today we will consider whether to propose a rule that would prove instrumental in our efforts to bolster investor confidence, protect investors, and maintain fair and orderly markets.
The proposed rule – called Regulation SCI – stands for systems, compliance and integrity. The rule would require entities essential to the smooth functioning of the U.S. securities markets to have comprehensive policies and procedures regarding their technological systems.
In particular, the rule is designed to assure that:
- These systems have adequate capacity, integrity, resiliency, availability, and security.
- Such systems operate in the manner intended.
- These entities are well-positioned to promptly take appropriate corrective action when problems arise.
This is a vitally important proposal and I am very pleased by and thankful for the efforts that have brought us here today.
Over the past two decades, the U.S. securities markets have experienced a remarkable evolution from a collection of relatively few, mostly manual markets. Today those markets are comprised of a broader variety of many more trading centers that are almost completely automated, and dependent upon sophisticated technology and extremely fast, interconnected systems. This, combined with the increased speed and capacity of automated systems, has contributed to an impressive surge of trading volume and message traffic.
While the benefits of technology cannot be overstated, this evolution has increased the complexity of the markets and presents challenges for market participants seeking to manage their information technology programs and ensure compliance with our laws and rules. Indeed, recent high profile events have highlighted the systems problems that could arise as a result of a reliance on such technology. The May 6 flash crash, systems issues that arose during the IPOs of Facebook and BATS Global Markets, the hacking of Nasdaq’s trading systems, and the closing of U.S. markets in response to Superstorm Sandy all exemplify the types of problems and disruptions that can affect our marketplace.
While it is not possible to prevent every technological error each market participant may commit, as the overseer of our securities markets it is the Commission’s responsibility to ensure that our regulations are designed to minimize their impact on our markets and ultimately investors.
In response to these issues, the Commission has taken several significant measures to make our securities markets safer and more efficient. We have put rules in place for revised market-wide circuit breakers and a new limit-up/limit-down mechanism to pause trading when markets move too far, too fast. We have clarified up front when erroneous trades are to be broken. We have effectively prohibited stub quotes and barred naked access to the market – among other things.
In addition to minimizing the impact of systems errors, we also have taken steps to reduce the likelihood of such errors in the first place. For instance, the market access rule requires brokers and dealers to put in place risk management controls and supervisory procedures designed to manage risks posed by potential technological malfunctions. Robust systems creation, maintenance, and review have essential roles in the effective prevention of systems errors. And Regulation SCI will require market participants to recognize this.
For more than 20 years, the Commission has had in place a voluntary program for exchanges and other self-regulatory organizations (SROs) known as the Automated Review Policy Inspection Program (ARP). That program originated from the Commission’s ARP policy statements and focuses on improving the automated systems of the SROs and other entities.
Through ARP, the Commission has sought to promote many of the practices and standards discussed at the Commission roundtable conducted last October. The roundtable – about promoting stability in today’s markets – focused on best practices and how market participants might better prevent technology errors and mitigate the impact of them when they arise.
Panelists expressed the need for improved quality assurance, more comprehensive testing, and better real-time monitoring, as well as pre- and post-trade risk controls. They also discussed whether there should be regulatory or other mandates for quality standards and industry testing, and whether specific mechanisms such as “kill switches” are necessary to protect the markets from technology errors.
The Commission’s ability to hold these entities to the standards created under ARP, however, has been limited because the ARP Program was not established through the Commission’s rulemaking process. As a result, the Commission is considering the proposal of Reg SCI – a formalized regulatory framework that will require entities that are important to the smooth functioning of the U.S. securities markets to carefully design, develop, test, maintain, and surveil systems integral to their operations.
To achieve this, the proposed rule would replace the voluntary ARP Program, codifying and refining many of the principles under which it has operated. Proposed Regulation SCI would apply not only to SROs but also to certain ATSs, plan processors, and exempt clearing agencies, which together would be encompass “SCI entities.”
The proposed rule would also help to ensure that our U.S. securities markets are better insulated from disruption from technology failures and deficiencies in controls by requiring that significant market venues are held to enhanced and more explicit technology and control standards, which the staff will describe in more detail. The regulatory framework being considered today would be an important step forward in the Commission’s oversight of the U.S. securities markets, and Reg SCI would help to ensure that our markets remain resilient against technological vulnerabilities.
Before turning the meeting over to John Ramsay, Acting Director of the Division of Trading and Markets, to discuss the proposed rule, I would like to express my thanks to John as well as to Jim Burns, David Shillman, Heather Seidel, David Liu, Beth Badawy, Tory Crane, Heidi Pilpel, Yue Ding, Sara Hawkins, Jon Balcom, Dhawal Sharma, and Gordon Fuller from the Division of Trading and Markets for their work on this rulemaking.
Thank you as well to Meridith Mitchell, Janice Mitnick, and Robert Teply from the Office of the General Counsel; Craig Lewis, Amy Edwards, Hans Heidle, and Mike Watson from the Division of Risk, Strategy, and Financial Innovation; John Polise, Connie Kiggins, and Michael Hershaft from the Office of Compliance Inspections and Examinations; and Tom Bayer and Todd Scharf from the Office of Information Technology.
I also would like to thank the other Commissioners and all of our counsel for their work and comments on the proposed rule.
Now I'll turn the meeting over to John Ramsay to hear more about the Division’s recommendation.