Market Regulators Failed to Heed Own Warnings

FINRA urged the SEC as recently as April 23 to confront these issues and others regarding who is doing what, where and when, calling for a "holistic" approach where regulators can "monitor and detect problematic activity across markets and products, not just within each market and market segment."

Elsewhere in its letter, FINRA said "gaps" in current audit trail data leave U.S. equity markets vulnerable to exploitation and leave open the possibility that market participants could mask their identities if they chose to.

"By spreading activity across different market centers, firms could potentially attempt to disguise abusive trading activity by exploiting the existing gaps in audit trail data," the letter reads.

>>>FINRA's Comment Letter to the SEC

The risks of sponsored direct market access, or DMA -- arrangements that may have played a role in the May 6 trading turmoil -- were also addressed in FINRA's letter. The regulator said audit trail data needed to be "transparent so that market participants' trading activity is discernable to regulators, and they are not able to mask their identity through the use of multiple market participant identifiers [MPIDs] or the MPID of another broker-dealer."

Again, the SEC was already moving to effectively prohibit sponsored DMA arrangements, introducing a proposal for a rule in January, but it's not effective yet.

In testimony prepared for a Congressional panel Tuesday, SEC Chairman Mary Schapiro candidly acknowledged that regulators haven't been able to keep up with the markets:

"One of the challenges we face in recreating the events of last Thursday is the reality that the technologies used for market oversight and surveillance have not kept pace with the technology and trading patterns of the rapidly evolving and expanding securities markets."

-- Written by Michael Baron in New York.

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