SEC Takes Action to Ban Unfiltered Market Access and Approves Issuance of Concept Release on National Market Structure

January 14, 2010

On Jan. 13, 2010, the Securities and Exchange Commission proposed new rules that will prohibit broker-dealers from providing their customers (including investment managers and funds) with “naked” access to an exchange or alternative trading system (“ATS”). The SEC voted to issue a concept release seeking comment on broad market structure issues, including high-frequency trading, co-location, dark pools, ATSs and other features of the national market system that recently have increased in importance. Neither of the releases is available yet, but this alert will summarize the discussion at the SEC’s open meeting.

Proposed Rules for Sponsored Access Arrangements

The SEC voted unanimously to propose new rules that will prohibit broker-dealers from providing customers with direct, unfiltered or “naked,” access to an exchange or ATS. The proposal is aimed to address concerns about such access, across all securities markets, in which a broker-dealer lends its market participant identifier (“MPID”) to customers such as hedge fund managers or other institutional investors who use it to trade directly on exchanges or an ATS without pre-trade monitoring by the broker-dealer.

Earlier in the day, the Commission approved a Nasdaq proposal for similar rules addressing Nasdaq member firm sponsored access.1 The Nasdaq’s rule change amends Nasdaq Rule 4611(d) to: (1) define categories of electronic access and explicitly include direct market access (access through systems solely controlled by member) and sponsored access (access through systems not solely controlled by member); (2) require certain specific systemic financial and regulatory controls; (3) require certain contractual commitments for sponsored access; and (4) require the real-time receipt and timely review of relevant trade activity reports. The Nasdaq rule release also notes that Nasdaq is working to develop a proposal that would require members who provide sponsored access to obtain a unique MPID for each sponsored market participant.

The SEC sponsored access proposal specifically requires broker-dealers that offer direct access to establish, document and maintain a system of risk management controls and supervisory procedures that are reasonably designed to manage the financial, regulatory and other risks related to its market access. In particular, the proposal requires broker-dealers to implement risk management controls and supervisory procedures that are:

  • Applied on a pre-trade basis to all trading activity that occurs under the broker-dealer’s MPID; 
  • Designed to prevent the entry of orders that exceed pre-set credit or capital thresholds, and to reduce the chance of erroneous order entry (both due to human and systemic errors);
  • Designed to restrict access to allow for only authorized and trained broker-dealer personnel to have access to an exchange or ATS;
  • Maintained under the direct control of the broker-dealer with market access — outsourcing of risk management and supervision of access is not permitted; and 
  • Subject to annual review and CEO certification.

SEC Chairman Mary Shapiro and several of the Commissioners referenced recent estimates that unfiltered access accounts for 38 percent of daily equity trade volume in the U.S. markets. The proposed rules would seek to curb the risk, both to the marketplace and broker-dealers, that these unfiltered access arrangements raise by allowing orders to transmit to the marketplace without going through a broker-dealer pre-screening process. Robert Cook, director of the SEC’s Division of Trading and Markets, argued that the proposed rules are necessary because a broker-dealer’s reliance on a customer’s controls when granting unfiltered access is simply insufficient. Commissioner Kathleen Casey, while supporting the proposed rule as a “defensible approach” to regulating access, stressed that the Commission should examine the entire set of market structure issues before deciding on specific issues such as sponsored access. Commissioner Luis Aguilar referred to sponsored access as a “worrisome practice” that may sacrifice risk controls for the sake of speed.

Commissioner Elise Walter asked whether the proposed rule should provide more detailed criteria for controls (for example, providing specific credit and capital thresholds that broker-dealers must implement) rather than applying the broad standard that is currently set forth in the proposed rules. The Division of Trading and Markets Staff responded that the proposed rule is designed to be broad in order to account for the various broker-dealer and customer models that are engaged in sponsored access arrangements. The Staff stressed, however, that comments on the issue of more detailed criteria would be particularly welcome. Commissioner Walter also asked whether a “gap” exists in the proposed rule insofar as it does not apply to ATS subscribers who are not broker-dealers. The Staff acknowledged that such a gap exists because some ATSs allow institutional investors to subscribe directly without using a broker-dealer to obtain access , but stated that in their view it is not a significant one.

Chairman Shapiro, the Commissioners, and the Trading and Markets Staff strongly encouraged market participants to comment on the proposal.

Concept Release on National Market Structure

Following the approval of the sponsored access proposal, the Commission voted unanimously to issue a concept release that seeks comment on broad market structure issues for the U.S. equities markets. The concept release will focus on three primary areas, including:

  • The performance of the national market structure today, particularly from the viewpoint of a long-term investor
  • The tools and strategies used by “high-frequency traders” (i.e., high-speed proprietary trading firms) and the impact of those tools and strategies on the broader market (e.g., whether co-location services give some investors an unfair advantage)
  • The impact of “dark trading,” including trading in dark pools, ATSs, and other market centers that do not report quotes to the consolidated tape

Chairman Shapiro and the Commissioners emphasized their desire to understand market structure issues and the need for broad comments from all market participants on this concept release during the 90-day comment period. 


The proposed sponsored access rule will add additional requirements and layers of compliance and supervision (e.g., application of risk management controls to customer trading in addition to trading by the broker-dealer). We encourage you to review and consider the proposed rule in light of current practices to determine the impact on your business. We also encourage you to review the forthcoming concept release on national market structure and provide comment during the generous 90-day comment period. Please let us know if we can be of assistance to you in regard to either of these releases. The releases should be posted on the SEC’s website in the near term.

For additional information concerning this alert, please contact the following lawyers:

Amy Kroll, Partner, Broker-Dealer Group, 202.373.6118

David Boch, Partner, Broker-Dealer Group, 617.951.8485

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area, 617.951.8615

Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area, 617.951.8620


This article was originally published by Bingham McCutchen LLP.