SEC Schapiro's Opening Salvo At Knight Capital's Apparent Trading Error

August 6, 2012

Bill Singer Engages Mary Schapiro In An Imaginary Debate

On August 3, 2012, Securities and Exchange Commission ("SEC")  Chair Mary Schapiro issued a statement on the trading issues that had involved Knight Capital Group.  Her comments were published in an SEC press release: Chairman Schapiro Statement on Knight Capital Group Trading Issue (#2012-151, August 3, 2012).  I present Schapiro's comments in italics below with my responses.  An imaginary debate, if you will.

Schapiro: The apparent trading error by Knight Capital Group on Wednesday reflects the type of event that can raise concerns for investors about our nation's equity markets - markets that I believe are the most resilient, efficient, and robust in the world.

Singer: I think that we're quite a ways past characterizing this event as an "apparent" trading error but given that Schapiro's statement was addressing a fast-evolving situation, her caution was understandable.  Notwithstanding, that old chestnut about our equity markets being the "most resilient, efficient, and robust in the world" strikes a false note with me.  Looking back over the past couple of years of market crashes, burns, wheezes, and fits, I'm not sure that we should be extolling the purported virtues of our dysfunctional system - particularly since the SEC has hardly proffered a convincing explanation of why the Flash Crash occurred or how come the BATS and NASDAQ/Facebook market miscues still managed to roil the markets.

Schapiro: Reliance on computers is a fact of life not only in markets everywhere, but in virtually every facet of business. That doesn't mean we should not endeavor to reduce the likelihood of technology errors and limit their impact when they occur.

Singer: The SEC cannot be some sideline cheerleader or color analyst during a sporting event.  We don't need commentary and observation from the SEC. We need ongoing regulation and oversight.  I have no foolish expectation that any regulator - no matter how competent or well intentioned - will ever eliminate technological or human error.  That would be an unrealistic goal; however, I don't need restatement of the obvious or a rah-rah pat on the back that the SEC should endeavor to reduce technological errors in the markets. Should?  In 2012 we're still using the word "should?"

Schapiro: While Wednesday's event was unacceptable, I would note that several of the measures we instituted following the Flash Crash helped to limit its impact. Recently-adopted circuit breakers halted trading on individual stocks that experienced significant price fluctuations, and clearly defined rules guided the exchanges in determining which trades could be broken giving the marketplace certainty.

Singer: Now that's more like it!  Right out of the box, Schapiro tags the Knight event as "unacceptable." No ifs, ands, or buts. I like that the SEC's Chair placed her marker firmly on the table so early in the game. On the other hand, she also seems to have laid off some of her bet by diluting the power of her first call with the same pap that typically comes out of a regulator whose agency may come under scrutiny - we instituted this, we helped with that, we adopted this, we defined that.  Respectfully, whatever the SEC did or didn't do with the Flash Crash doesn't seem to have truly gotten the job done with BATS, with NASDAQ/Facebook, or with Knight. All of which underscores the dangers of fighting the last war's battles.  The SEC needs to up its game. Our federalWall Street cop can't gloss over the recent disclosures about MF Global, JP Morgan, and Peregrine Financial Group - or its failed handling of Madoff and Stanford.

Schapiro: In addition, existing rules make it clear that when broker-dealers with access to our markets use computers to trade, trade fast, or trade frequently, they must check those systems to ensure they are operating properly. And, naturally, we will consider whether such compliance measures were followed in this case.

Singer:  Ummm . . . what?  Are we still relying upon the foxes to guard the hen house?  Perhaps one continuing failure of our regulatory system is an over-reliance upon industry participants to "check those systems to ensure they are operating properly."  Sure, as a first-line of defense or compliance that's one thing - but that can't be the entire protocol.  Local fire departments conduct inspections of their area's businesses and residences. Many cities are adopting surprise restaurant inspections with the issuance of publicly-displayed grades. Those are examples of two-part regulatory/compliance schemes that encourage self-inspection and compliance tempered by a government agency's audit.  After all, if a homeowner fails to install smoke alarms, the "market impact" could well be the death of a family and loss of adjoining homes.  If a restaurant fails to properly store food, the "market impact" could be painful illness, if not death.  Not to be playing Monday Morning Quarterback or using the hindsight vision of 20/20, but when a market-making Ax of the size of Knight is planning on a major trading system shift, you think that it might have been a good idea to not only have SEC  staff witness Knight's pre-launch testing and back-up capabilities but also have a team from the federal regulator on-site the day of the launch?

Schapiro: As with every significant incident of volatility that occurs in our markets, we will continue to review what happened and determine if any, additional measures are needed. That process has already begun.

Singer: Everytime there's a "significant incident" the regulators "continue to review" and assure us that some "process has already begun."  Perhaps you folks who are policing Wall Street might take a breath, just for a second, and acknowledge that your timeless response to these incidents hasn't quite gotten the job done. What the industry and public will likely observe is about a year's worth of review and investigation, followed by a lot of sacrificial lambs being slaughtered for the spectacle, and lots of roundtables and White Papers suggesting credible solutions that will be watered down in Congress (should they even see the light of that day).  The trouble with witch hunts is that there really aren't any witches.  How about thinking outside of the box this time?  How about first trying to fix the problem so it doesn't recur - and then worrying about who to blame and how many dollars in fines to seek?

Schapiro: In particular, I have asked the staff to accelerate ongoing efforts to propose a rule to require exchanges and other market centers to have specific programs in place to ensure the capacity and integrity of their systems. And I have directed the staff to convene a roundtable in the coming weeks to discuss further steps that can be taken to address these critical issues.

Singer:  Oh my, I wrote my prior paragraph before seeing this one - oops, another roundtable.  For my dismissive take of this proposal, READ: At The Head Of The Roundtable (, October 2, 2009) - please note the date of the article's publication: 2009! Also, view my recent video interview about last week's then unfolding Knight incident at