SEC Large Trader Identification Proposal
By Kevin Tyrrell
The SEC recently proposed new rules for large traders. Kevin Tyrrell of Bank of America Merrill Lynch provides us with a snapshot on what constitutes ‘large traders,’ and the scope of their responsibilities and the brokers’ under this proposed rule.
U.S. equities and options trading has experienced several significant changes over the past few years. Some of the most important trends have been increased fragmentation, increased market volume, the growth of high-frequency trading (HFT), and (for equities trading) the rise in dark pool and other off-exchange trading. These factors have made analyzing market activity far more difficult, and the rapid growth of HFT has led many to question what that business entails. In response to this increased complexity and the general concerns about high-frequency trading, the SEC has proposed a Large Trader Identification rule in order to better review market activity.
A primary motivation for this rule is to allow the SEC to more easily review trading activity that can be dispersed across several executing brokers. Currently, the SEC has the ability to gather all information necessary to reconstruct market scenarios and determine which end users entered orders that affected securities prices. However, the process for gathering such data is slow. The SEC needs such end user information in a more accessible format in order to assess significant market activity. The dramatic events of May 6, 2010 and the subsequent search for the root cause of the dramatic price drops show the substantial challenges faced in determining exactly what and how forces can impact the markets.
What is a “Large Trader”?
In the current proposal, the SEC defines a large trader as any entity (either a firm or individual) who, in exercising investment discretion over an account, executes a total of 2 million shares or $20 million notional value of NMS (National Market System) securities in a single calendar day, or 20 million shares or $200 million notional value in a calendar month1. This definition encompasses all exchangelisted securities, both equities and options, with options activity determined by multiplying the number of contracts traded by the contract amount (i.e., an options trade of 50 contracts would count as 5,000 shares). The SEC considers this to be a relevant benchmark for large traders as it represents 0.01% of the double-counted daily market volume. There are no specific or broad-based exemptions proposed to the definition of large trader: any firms or individuals meeting the activity thresholds will be considered large traders.
What Does Being a Large Trader Mean?
Any person or firm meeting the Large Trader definition must selfidentify to the SEC, using the new SEC Form 13H. This form includes basic identifying information about the firm, including its type(s) of trading activity, as well as account identification information for the accounts for which the Large Trading occurs. The SEC will then issue the Large Trader a Large Trader Identification Number (LTID), which the Large Trader must then provide to all of its executing brokers. A Large Trader is required to selfidentify and register with the SEC promptly after the activity which triggers Large Trader status, and is also required to submit the form annually in recognition of its ongoing status as a Large Trader.
The executing broker is responsible for maintaining the LTID and related account information for all clients, and must be able to provide trade information including the LTID(s) as soon as T+1. To facilitate its analysis and market reconstruction capabilities the SEC is proposing two additions to the current Electronic Blue Sheet (EBS) system: LTID and execution time. The broker will then be expected to be able to respond to information requests as soon as T+1, and to provide the data, including the newly-required LTID and execution time fields, to the SEC within the time specified in the request. The data report should include all executions meeting the “reporting activity level” of at least 100 shares (and any other executions the broker deemsrelevant) 2. Additionally, in the event that multiple LTIDs maintain investment discretion over single account, the broker must be able to report the multiple LTIDs associated with that account’s activity.
Brokers also have responsibilities relating to firms not registered as Large Traders, but with a safe harbor provision. Essentially, brokers must have policies and procedures that can detect activity levels that approach or exceed the threshold amounts for Large Traders and confirm that the clients directing such activity are registered as Large Traders. The SEC says it would consider disclosure of Large Trader reporting requirements at the time of account opening, as well as notifications to unregistered clients as they approach the threshold, to fulfill the notification aspect of the safe harbor provision. If the broker has such procedures in place, and also does not actually know that the trader is a Large Trader, the safe harbor provision would generally be considered fulfilled. If a broker is aware that a client meets the definition of being a large trader but has not registered (e.g., is an “Unidentified Large Trader”) the broker is responsible for tracking that trader’s activity in much the same way as a registered Large Trader is tracked. In lieu of the LTID, Unidentified Large Traders’ activity must be identified by the Trader’s name, address, account opening date, and tax ID number 3.
Furthermore, brokers have a responsibility to assess their own activity and determine if they are required to register themselves as Large Traders. Like any other market participant, if the broker meets the execution threshold amounts by trading in an account over which it exercises investment discretion, it must file Form 13H and register as a Large Trader with the SEC. The broker must then share this LTID with any other broker through whom it may trade, and also be prepared to submit details of its own activity as it would for any of its Large Trader clients.