In Praise Of A Politician. Seriously.

I know nothing about Senator Edward Kaufman of Delaware, but based on his letter below, I’m beginning to like him.

I’m glad to see someone – anyone – inside the Beltway step up on behalf of the individual investor, especially in light of this high frequency trading debacle. I confess I had doubts that anyone with real legislative influence would wade into the debate. Wouldn’t want to interrupt all that mindless bickering, after all. Yet here comes the gentleman from Delaware.

Kaufman 1, Cynicism 0.

Here is the letter in its entirety, from RealClearMarkets.com. These issues are bigger than politics.

A Level Playing Field For Investors

By Sen. Edward Kaufman

Efficient and free capital markets are essential to all that makes America great: investment in private enterprise, the availability of capital to expand and grow our economy through innovation, and the ability to save for retirement in hope our investments will support us in later years.

Regrettably, we now have an unfair playing field for investors. This leaves us with, in effect, two financial markets: one for powerful insiders, who use high-speed computers and privileged access to information to exploit loopholes for profit, and another for the average investor, who must play by the rules and whose orders are filled almost as an afterthought. This situation simply cannot continue. It is the financial equivalent of “separate and unequal.”

Every day we learn more about the features of this two-tier system. Dark pools, collocation of high-speed computers at the exchanges, flash orders. Abusive short selling, the loophole of choice in 2008, was only the first sign of how the powerful on Wall Street make profits unhindered by the rules the rest of us must follow.

Here are just four areas where the SEC needs to act urgently to protect investors and restore market integrity.

First, the SEC should restore the substance of the uptick rule. This rule, a mainstay of investor protection for 70 years until it was repealed in June 2007, required investors simply to pause and to wait for an uptick in price before continuing to short sell. Without such a rule in place, investors who own stocks are more vulnerable to organized “bear raids” – abusive short selling combined with coordinated “misinformation” campaigns – which many believe contributed to the demise of Lehman Brothers and Bear Stearns, key elements in the collapse of our financial markets last year.

Second, the SEC should implement tougher rules that will stop naked short selling through an enforceable system. Naked short selling is the practice of selling stocks without first locating or borrowing the actual shares needed for timely delivery at settlement, sometimes in a concerted action to manipulate a stock price downward. This week, the SEC made permanent a temporary rule they had enacted last fall, proposed some new transparency measures, and announced plans for a Roundtable discussion on September 30.

That is some progress, but not enough. Two months from now, the Commission will finally begin to discuss publicly the potential solutions that I and a bipartisan group of Senators have been urging: either a pre-borrow requirement or a centralized “hard locate” system, which would prohibit short selling unless the executing broker first obtains evidence of a unique identifier number associated with specified shares set aside for timely delivery. The Depository Trust & Clearing Corporation tells us that it has the capacity and the willingness to implement that system – but only if the SEC requires it through a rule.

Third, the SEC should ban the use of so-called “flash orders” by high-frequency traders. Flash orders allow exchange members who pay a fee to get a first look at share order flows before the general public. By viewing this buy and sell order information for just milliseconds before it goes to the wider market, these investors gain an unfair advantage over the rest.

As the New York Stock Exchange complained to the SEC on May 28, selling flash orders for a fee provides “non-public order information to a select class of market participants at the expense of a free and open market system.” To use a baseball metaphor, flash orders allow some batters to pay to see the catcher’s signals to the pitcher, while the rest of us don’t see them. Markets that permit a privileged few to have special access to information cannot maintain their credibility.

Amazingly, it is a loophole in current regulations that allows this unfair practice. This can and should be fixed immediately.

Finally, the SEC should establish disclosure and transparency equality: the disclosure requirements that apply to pooled funds worth greater than $100 million should apply uniformly to all, including hedge funds, for both long and short positions. And the level of transparency for order flows should be the same for all.

When millions of Americans have lost so much money in the stock market, how can we expect them to reinvest their savings when Wall Street players continue to make record trading profits by exploiting loopholes using high-speed computers? William Donaldson, former Chairman of the SEC and the New York Stock Exchange, has said “This is where all the money is getting made . . . If an individual investor doesn’t have the means to keep up, they’re at a huge disadvantage.”

America was founded on the principle of equal opportunity. While we should keep encouraging the kind of commercial ingenuity that fuels the prosperity of our financial markets, we must ensure that technology is not employed to advantage one small group over the rest. The SEC must deliver on investor protection to restore the integrity and credibility of America’s financial markets.

Margaritas on me, sir, if you’re ever in the Keys.

H/t Tyler Durden.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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One Response to In Praise Of A Politician. Seriously.

  1. Kirk Kinder says:

    The first rule of Wall Street – make money at the expense of your “client.”
    The second rule of Wall Street – make money at the expense of your “client.”
    The third rule of Wall Street – bribe any politician who messes with rules 1 and 2.