Broker-dealers who are sponsoring their customers' direct access to securities markets need to face a "higher level of accountability with respect to the algorithms they use,'' according to their chief regulator.
Richard Ketchum, the chairman and chief executive of the Financial Industry Regulatory Authority, said Tuesday that the higher standard of accountability needs to be applied to algorithms whether they come from the firm itself or a vendor and, most particularly, if the algorithms are "used across a wide range of borses.''
Ketchum made his comment at a financial markets conference at Baruch College. The comment follows a unanimous Securities and Exchange Commission vote in January to to propose a new rule that would effectively prohibit broker-dealers from providing customers with "unfiltered" or "naked" access to an exchange or alternative trading system.
This is not to say that firms will be expected to know exactly how their algo will act with an event that has never happened before, such as the May 6 Flash Crash. Ketchum said regulators realize "each exceptional event" may cause difficulties with an algo.
But potential effects on electronic markets have to be scrutinized -- in advance, he said.
In general, he said, "it is to say: if you're operating from a broker dealer and you do not have a process in place, you do not have any analysis with respect to those things, you have a regulatory problem and if anything I think we need to think of ways to accelerate that accountability."
He said FINRA "will devote a lot of resources to look at that,'' including whether there needs to be more clarity on rules "or whether there ought to be greater personal responsbility from the leadership at a firm aspect (on) what they engage in."
There are no easy answers, he said.
"This is hard. What I am interested in is seeing behavior improve,'' he said.
"There may be situations in which people need to be held accountable from the standpoint of how they operate. But i think this is a reality that has shifted and shifted fairly quickly,'' he told a gathering of market participants, academics and students.
"My concern is to make sure if people have not put pre-trade controls in place, they should have them in place. If they impact the market improperly, hopefullly we and the NYSE will bring cases and will continue to hold people accountable,'' he said.
"I think the appropriate place to focus now is to increase the auditing that firms do when they introduce new algorithms and particularly when their customers introduce new algorithms,'' he said.
The auditing should analyze a number of scenarios on how the algorithm could impact markets, he said.