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In Letter To Schapiro, Schumer Urges Update To 'Market Maker' Definition To Ensure High-Frequency Traders Acting Like Market Makers In 25 or More Stocks are Subject to Affirmative Obligations

Enhanced Obligations Would Prevent High Frequency Traders From Withdrawing From Markets En Masse—Sudden Loss of Liquidity Contributed to Market Meltdown on May 6

With SEC Mulling Reforms To Prevent Another Market Crisis, Schumer Says Proposals Could Represent 'Consensus'

WASHINGTON, DC—U.S. Senators Charles E. Schumer (D-NY) today urged the Securities and Exchange Commission (SEC) to place certain high-frequency trading firms under a uniform set of rules to prevent them from pulling out of markets en masse as they did during last May’s flash crash that sent stock prices tumbling. Schumer said updating the agency’s 17-year-old “market maker” definition so that more of these traders had affirmative obligations when it comes to providing liquidity could go a long way towards preventing future volatility in stock prices.


“The Commission should require any market participant effectively making markets in 25 or more symbols to be subject to market maker obligations.  Requiring more high frequency traders to be legally obligated to step in and provide liquidity would go a long way in helping to avoid sudden, rapid price plunges like the May 6 Flash Crash,” Schumer said in a letter to SEC Chairman Mary Schapiro.


Schumer proposed a number of new obligations that would be imposed on all traders who are dealing in 25 or more stocks. These include a best price obligation that would require market makers to quote between the highest bid and lowest offer price for a minimum amount of time during each trading day, and require that market makers quotes be reasonably related to the market price, which would effectively ban so-called “stub quotes”, which are widely believed to have contributed to market volatility on May 6. Many of these obligations are currently imposed on designated market makers by the New York Stock Exchange, but not all trading venues have designated market makers or impose affirmative market-making obligations on market participants.  Schumer also said the proposed obligations should apply uniformly across all trading platforms to ensure a level playing field and avoid the kind of disorderly markets experienced on May 6.


Since many of these proposed requirements enjoy preliminary support from leading market makers and market participants, Schumer suggested a “consensus” was already emerging around these ideas.


A copy of Schumer’s letter to Schapiro appears below.


August 11, 2010


Mary Schapiro, Chairman

Securities and Exchange Commission

100 F Street NE

Washington, DC 20549


Dear Chairman Schapiro, 


The causes of the May 6 Flash Crash are still under investigation, but we have learned a number of important lessons about our markets and how they have dramatically changed in the past few years, presenting new risks.  I am writing to express my concern about certain of those developments and to respectfully suggest that the Commission consider steps to address the risks they pose to investors and to the integrity of our markets.


One of the most important new developments – and one that many observers and market participants think contributed to the market’s volatility on May 6 – is the role that high frequency traders now play as de facto liquidity providers.  The traditional definition of bona-fide market makers developed to describe the upstairs specialists of the old trading floors is now largely irrelevant.  During the May 6 Flash Crash many high frequency traders pulled out during the freefall, leaving a dearth of liquidity and exacerbating market volatility.  This disappearance of high frequency traders and their withdrawal of liquidity reveal a serious problem with our market regulation.  The players in our markets have changed but our regulations have not kept pace.


Accordingly, I respectfully urge the Commission to consider the following proposals to restore confidence in our markets and reduce the likelihood that another, potentially more severe Flash Crash, occurs. 


First, the Commission should update its definition for “bona fide market maker”.  The definition of “bona fide market maker” has not been updated since 1993 and therefore does not reflect the new market landscape of high frequency traders and alternative trading systems.  The reality is that many high frequency traders are today’s de facto market makers.  However, they are not subject to the legal obligations of market makers. 


The Commission should require any market participant effectively making markets in 25 or more symbols to be subject to market maker obligations.  Requiring more high frequency traders to be legally obligated to step in and provide liquidity would go a long way in helping to avoid sudden, rapid price plunges like the May 6 Flash Crash.


Second, the Commission should bolster the obligations of such market makers to provide meaningful liquidity and stability in the markets.  I respectfully request that the Commission consider incorporating the following market maker obligations:


  • Best Price Obligation: Market makers should be required to quote between the highest bid and lowest offer price for a specified percentage of time during the trading day depending on stock price, trading volume and other characteristics of the stock.  This would ensure that market makers provide meaningful liquidity at market prices.


  • Maximum Quoted Spread: Market makers should also be required to post quotes that are reasonably related to the then-current market price, presumably within the percentage triggers for circuit breakers.  This would eliminate the practice of posting so-called “stub quotes”, widely believed to have led to many of the cancelled trades on May 6.


  • Depth Obligation: Market makers also should be required to provide multiple price levels below the best price obligation depending on volume, stock price and other characteristics of the stock.  Making markets should not be limited to the superficial level of the best price.  In order to be strong, resilient and less volatile, markets should be as deep and liquid as possible.


  • Uniformity Across Trading Venues: Perhaps most importantly, the eligibility requirements and obligations of market makers should be uniform across all exchanges and trading venues.  Some exchanges require fewer obligations of their market makers than others.  It is important that there is a level playing field between all trading venues and that this playing field has high standards that protect the best interests of long-term investors.


A consensus is emerging around many of these proposals, not only among exchanges but also among many leading market makers and other market participants, who sent you a letter advocating many of these proposals on July 13.


The above obligations are burdensome and making markets is voluntary, so the Commission should consider appropriate incentives for high frequency traders to become market makers.


I commend the excellent work you and your staff are doing, and I look forward to working with you on these important issues.





Senator Charles E. Schumer


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