An irreverent Wall Street Blog
A History of SOES, Daytrading, NASD, NASDAQ, DOJ, SEC, Congress, and Robinhood
September 1, 2020
In the 1990s, Wall Street's establishment co-opted NASD into becoming a political tool against the Small Order Execution System ("SOES") Bandits and daytrading in general. Although there were legitimate concerns about the then-emerging era of online daytrading, Wall Street's regulatory establishment was more about preserving turf and protecting the industry's rampant price-fixing than about formulating effective rules to usher in a new, safer age of electronic trading. The Department of Justice's Antitrust Department and the Securities and Exchange Commission took tepid actions in response to the industry's price-fixing, the politicization of Wall Street regulation, and the inappropriate relationship between the NASDAQ market and its NASD self-regulator. On the other hand, those of us who were veterans of those battles recall that it was the Tech Wreck and 9/11 that tossed the SOES community and the old direct-access firms into the dustbin of history. Virtually no meaningful regulation emerged in response to the excesses of direct access/daytrading in the 1990s, and that may be the dangerous legacy before us today.
Once again, we find ourselves hunkering down in a no-man's-land between regulators and the regulated -- as those who advocate an individual's right to take on risk in their personal trading decisions confront those who advocate a role for rational regulation to stem what they view as financial suicide. We should remember that with the explosion of daytrading in the 1990s, we experienced suicides and even murders as a result traders who lost everything. When we confront the 2020 tragedy of 20-year-old Robinhood daytrader Alex Kearns, we would be wise to recall the 1999 murder spree of daytrader Mark Barton.
In 2020, we should consider the explosion in daytrading that has been fueled by Zero Commission app-based trading amid the COVID pandemic. There are too many inexperienced traders sitting at home "playing" the market and sliding down the slippery slope of financial suicide. Will the unlearned lessons of the past and some of the more lurid headlines of recent weeks prompt sensible, effective regulation? Likely not because such efforts tend to be eviscerated by powerful and influential Wall Street participants. It's not a new story or a surprising outcome. It is, however, a sad turn of events and a dispiriting way to regulate.
As recently reported in part in Robinhood's Rise Brings Dark Side of Irate Traders, U.S. Probes (Bloomberg by Robert Schmidt and Benjamin Bain / August 31, 2020)
https://www.bloomberg.com/news/articles/2020-08-31/robinhood-s-rise-brings-dark-side-of-irate-traders-u-s-probes?srnd=premium:, the wheels are already turning as the likely battle lines are being drawn. At Robinhood, for example, former SEC Commissioner Daniel M. Gallagher (2011 to 2015) was brought on board. In 2008, Gallagher was the SEC's Deputy Director of the Division of Trading and Markets, and from April 2009 through January 2010, he served as the Division's Co-Acting Director. As reported in part by Bloomberg's Schmidt and Bain:
https://www.bloomberg.com/news/articles/2020-08-31/robinhood-s-rise-brings-dark-side-of-irate-traders-u-s-probes?srnd=premium:, the wheels are already turning as the likely battle lines are being drawn. At Robinhood, for example, former SEC Commissioner Daniel M. Gallagher (2011 to 2015) was brought on board. In 2008, Gallagher was the SEC's Deputy Director of the Division of Trading and Markets, and from April 2009 through January 2010, he served as the Division's Co-Acting Director. As reported in part by Bloomberg's Schmidt and Bain:
To guide the company through that thicket, Robinhood brought on Gallagher, 48, as chief legal officer in May. An attorney who specializes in the often arcane world of broker regulation, Gallagher is friendly with lawmakers of both parties and more comfortable in the Washington uniform of a suit and tie than the tech world's hoodie and Allbirds sneakers. He's also brought deep relationships with government officials to the firm. Among his close confidants is SEC Chairman Jay Clayton.Last month, Gallagher hired another SEC insider, ex-Clayton Chief of Staff Lucas Moskowitz, to run Robinhood's regulatory, litigation and lobbying efforts. Moskowitz has worked for Republicans on the House Financial Services Committee and the Senate Banking Committee, and he's been an enforcement lawyer at the SEC. Robinhood also named new chief compliance officers at two subsidiaries in August, one who came from Wells Fargo & Co.'s brokerage and another from Fidelity.
Notwithstanding Robinhood's moves to enhance its in-house compliance capacity and to start building a team to deal with a possible Congressional and regulatory onslaught, the firm is still experiencing ongoing operational issues. As recently reported in part in Robinhood, TD Ameritrade Resolve Client Trading Glitches (Bloomberg by Annie Massa / August 31, 2020)
https://www.bloomberg.com/news/articles/2020-08-31/robinhood-reports-trading-problems-is-working-to-resolve-them?srnd=premium:
Robinhood had problems related to equities, options and cryptocurrency trading in the morning and said shortly after noon in New York that the issues were fixed. TD Ameritrade said in a statement that clients had experienced high levels of slowness on its web platform and mobile app. Both companies apologized.Charles Schwab Corp. and Vanguard Group also said they were working to resolve issues with their websites, among other disruptions. Thousands of customers lodged complaints on Downdetector.Speculation online focused on whether some of the problems were related to the Apple Inc. and Tesla Inc. stock splits effective Monday.
"High levels of slowness?" I guess that's one way of phrasing it. Another alternative is that the firm had a failure of "operational capacity," which might be the result of too-rapid a marketing expansion coupled with a failure to implement protocols to ensure scalability of the trading platform. This is not a new issue or a new concern. This is an ongoing challenge for Wall Street regulation but, sadly, a fumbled ball that tends to bounce around with dire consequences. It was only a few months ago on March 4, 2020, that the "Securities Industry Commentator" ran the following piece
http://www.rrbdlaw.com/5094/securities-industry-commentator/#robinhood
http://www.rrbdlaw.com/5094/securities-industry-commentator/#robinhood
Trading app Robinhood experiencing 'major outage' for a second day amid heavy volume market action (CNBC by Kate Rooney)https://www.cnbc.com/2020/03/03/trading-app-robinhood-experiencing-major-outage-for-a-second-day-amid-heavy-volume-market-action.htmlAs reported in part by Kate Rooney:
As U.S. stocks traded actively again Tuesday in wake of a surprise Fed rate cut, Robinhood reported a "major outage" for trading across its platform. Earlier updates on the site said that all trading was "operational," but Twitter users posted screenshots of error messages as U.S. markets opened Tuesday."We are experiencing a system-wide outage," a message read on Robinhood's website.Technical issues Monday lasted through the trading day, leaving users with their hands tied as the Dow Jones Industrial Average's biggest one-day point gain in history. On Tuesday, stocks surged off their lows after the Federal Reserve cut interest rates in an effort to stem slower economic growth from the coronavirus outbreak
Bill Singer's Comment: Maybe the SEC needs to re-visit "operational capacity"? At some point, either brokerage firms scale their operations to handle market gyrations or they will be held accountable via customer lawsuits. Imagine wanting (needing) to close out a position that's running against you but being unable to access your trading screen -- and, worse, being directed to a telephone system where staffing can't keep up with the flood of calls!
Of course, it's not as if the SEC and FINRA and other Wall Street regulators are unaware of the whole "operational capacity" issue for Robinhood and its competitors. Consider these remarks from the SEC's Director of Enforcement:
We are experiencing a sharp rise in the number of complaints we receive at the SEC from customers having difficulty accessing their accounts. We received 135 complaints of this nature in 1998 as compared with just 11 in 1997. In addition, a quarter of the firms reviewed in the OCIE on-line broker-dealer sweep placed little emphasis on evaluating systems capacity or had difficulty answering the staff's questions on the subject.It is important for firms to ensure that they have adequate contingency planning. OCIE found that most firms had alternative means of processing orders, normally by telephone. Some firms, however, lacked adequate staff to process their normal volume of trades in the event of an outage.How do you protect your firm from exposure for a series of system crashes? Simple, remember the basics. Once again, disclosure is your best friend. What impression does a broker-dealer give to its customers when it guarantees 60 second trade execution? Is this guarantee unconditional? Are sufficient risk disclosures made? I would not take for granted that investors know systems may crash and therefore deem risk disclosure unnecessary. As a competitive measure, a few on-line brokers are beginning to market themselves based on the reliability of their systems. Overly bold claims here could wind up getting a firm in hot soup should problems surface. . . .
Yes, I know, those are pretty on-point observations for August 2020, as just witnessed by Monday's online trading issues. The problem is that those comments are not from 2020. Nor are they from the current SEC Director of Enforcement -- you can review the full-text of the above speech at "On-Line Brokerage: Staying on the Right Side of the Line" (Speech by SEC Director of Enforcement Richard H. Walker / November 17, 1999)
https://www.sec.gov/news/speech/speecharchive/1999/spch319.htm
https://www.sec.gov/news/speech/speecharchive/1999/spch319.htm
Similarly, consider the Syllabus from the SEC's memory lane as set out in "On-Line Trading: Investor Protections Have Improved but Continued Attention Is Needed" (GAO-01-858 / July 20, 2001):
On-line trading continues to be an important part of the securities trading market. The industry reports investing greater resources to improve the performance of their systems, and regulators have made substantial progress in ensuring that investors receive better information in key investor protection areas. However, investors trading on-line continue to file many complaints about failures and delays in processing orders. GAO believes that providing complete information on the websites of on-line broker-dealers would allow investors to make more informed investment decisions.
Further, the July 2001 report to Congress notes in part that:
Currently, neither SEC, NASD, nor NYSE has a specific rule requiring broker-dealers to maintain records of system delays and outages and their related causes and to disclose the potential for service disruptions on their Web sites, nor is there currently a definition of delays and outages. OCIE's report does state that broker- dealers should consider maintaining records of capacity evaluations and systems slowdowns and outages, including details of the cause and impact. In addition, OCIE suggests that firms make every reasonable effort to inform customers of operational difficulties and provide all new customers with information in plain English on the risks of systems delays or outages. Although the OCIE report provides some useful guidance on operational capability issues, SEC has not yet defined what constitutes an outage or delay.According to an SEC official, SEC staff is currently considering proposing a rule that would implement operational capability standards for broker-dealers and address the problem of defining the term outage. That is, SEC staff is reconsidering a rule it had first proposed in March 1999. That proposed rule would have required, as a condition of conducting securities business, that broker- dealers have sufficient operational capacity to enter, execute, clear and settle orders, and deliver funds and securities promptly and accurately. In response to the March proposal, SEC received numerous comment letters generally stating that the proposed rule was "overly vague." . . .
at Page 23 of the July 2001 Congressional Report
Finally, recall these opening remarks of Senator Susan M. Collins (R. Maine), Chairman of the Senate Permanent Subcommittee on Investigations of the Committee on Governmental Affairs from February 24 and 25, 2000, as set forth in "Day Trading: Everyone Gambles But The House" (Sen. Hearing 106-505)
https://www.govinfo.gov/content/pkg/CHRG-106shrg64133/html/CHRG-106shrg64133.htm:
https://www.govinfo.gov/content/pkg/CHRG-106shrg64133/html/CHRG-106shrg64133.htm:
As the testimony today will show, most day traders are not breaking even. In fact, they are losing money, big money. The consumers who will testify before us today, for example, lost tens of thousands of dollars.The same cannot be said, however, for the day trading industry. It seems to be doing quite well. The 15 firms that we examined reported aggregate gross revenues of over $491 million in 1999 and aggregate profits of about $144 million. The Subcommittee found that the industry is growing by leaps and bounds. Indeed, the revenues of day-trading firms that we analyzed grew by a whopping 276 percent from 1997 to 1999.Everyone, even the industry, appears to agree that day trading is highly speculative and extremely risky. Both the Chairman of the SEC and the President of NASAA, that is the State Securities Regulators Association, went so far as to call day trading gambling during the Subcommittee's hearing last fall. The Electronic Traders Association, the trade organization for the industry, objects strongly to that analogy, contending that day trading requires skill, state-of-the-art technology, and hard work.That may be true, but many day traders seem comfortable with the comparison to gambling. The president of 1 day-trading firm was quoted in the press as saying that day trading is like blackjack. Documents obtained by the Subcommittee also indicatethat some firms consider day trading to be essentially gambling.
Bill Singer's Comment
Keep in mind that technically there is a difference -- and a critical one -- between on-line trading versus daytrading. The former is more of a convenience, whereas the latter is a style of investing. I trade online. I daytrade. I have no issues with either.
The more compelling regulatory issue for me is the ongoing challenges to brokerage firms' "operational capacity," and the frustrating persistence of trading platforms that freeze, lock-up, and crash. When customers are unable to access real-time quotes or asset valuations during a trading day, their efforts to obtain redress from their brokerage firm is typically inadequate if not futile. As I have personally experienced and as I have been told by many public customers seeking to retain my services to sue their brokerage firms, when your trading screen crashes, efforts to reach someone at the brokerage firm are often infuriating. During such crises, a customer may be on "hold" for 20 or more minutes trying to reach customer service. In many cases, there is inadequate staffing of on-line chat and telephone services. When a human being finally answers a call, that individual frequently seems to lack expertise to understand the issue or resolve it. In many cases, a customer finds herself bought-in or sold-out during such platform outages, and unable to obtain a reasonable resolution from the firm. Out of frustration, many customers will simply close out open positions as part of an understandable reaction to not wanting to be exposed to dramatic market intra-day swings while "blinded" by a locked-up trading screen. Frequently, those customers report getting the runaround when trying to obtain some recompense for any losses they suffered.
In recent weeks, I have noticed an odd development whereby many telephone conversations that are almost always tape recorded by a brokerage firm, suddenly seem not to have been subjected to that default protocol. Oddly, tape recordings memorializing the customer's timely complaint about operational capacity issues either were not made or, gee, sorry, but, what can I tell you, I asked the back office to pull the tape and they can't find it. I understand the whole missing tape thing. At times, someone forgets to activate the taping or there was some digital snafu. On the other hand, I continue to hear the same tale about missing tapes, and it seems to conveniently occur on days of extraordinary market volume. Yeah, I'm suspicious of one too many coincidences.
I'm an adult. I want to take risk when I want to take it and to the extent that I want to take it. That being said, intelligent regulation often confronts such an independent streak and tries to balance my desire to place $1,000 on one roll of the dice versus what may be in my own best interest, in that of my family, and, ultimately, "in the public interest." That is the tension by which regulations are promulgated. It's a balancing act between what some folks resist and others demand. It is a balancing act between keeping the flame of capitalism alive in the markets versus allowing that flame to burn down the planet. No -- there are no easy solutions. On the other hand, as today's blog makes clear, there is history -- and we should try to learn from our past mistakes and be wary of those proposing dubious solutions. Today, there are those who support wearing masks in response to COVID. There are those adamantly opposed to being forced to wear masks. We're barely regulating that public health crisis. Hopefully, the operational capacity of online trading will prove more susceptible to rational debate and prudent rulemaking. Candidly, I remain a skeptic and a cynic. Anyone know of a place where I can place a large bet that we don't get any workable regulation?