Victoria Pennington talks to Richard Ketchum, chief executive of NYSE Regulation, about the difficulties of dealing with the increased challenge of market surveillance and also discusses some of the major milestones in the development of the New York securities markets During periods of market volatility, opportunities for market abuse increase dramatically. And market abusers are becoming ever more sophisticated in the techniques they use to manipulate the securities markets. As chief executive of self-regulatory organisation NYSE Regulation, a not-for-profit US subsidiary of transatlantic exchange NYSE Euronext, Richard Ketchum is dedicated to strengthening market integrity during what looks like being a bumpy ride through the credit crisis. "Objectively our referrals have been up the last two years so we are seeing a disturbing amount of suspicious activity in the insider trading area in particular," says Ketchum. "In this time where the markets are so fragile and uncertain we take great concern over the potential for market manipulation and insider trading, and these are areas where we are constantly trying to improve our surveillance techniques both in the US and connecting with the European regulators." Ketchum is a lawyer by education but a fascination with the way money markets operate steered him on a more regulatory-orientated career course. He spent 14 years at the US Securities and Exchange Commission (SEC). During the earlier years of his time there, the markets were undergoing a seismic shift towards the use of electronic trading, improving the availability of trade and quote reporting information, and encouraging more competition. Through his work on an options trading study for the SEC, Ketchum was given the opportunity to sit behind trading desks, observing trading floors and learned about trading at the coal face - an experience that was to stand him in good stead for the rest of his career. The last seven years of his time at the SEC was served as the director of market regulation, trading and markets before he moved to the National Association of Securities Dealers (NASD), which at that time also owned the Nasdaq Stock Market. He spent 12 years there, serving as president of both organisations. After a brief sojourn as general counsel for Citigroup, Ketchum moved to the NYSE Regulation to become its first chief regulatory officer. NYSE Regulation is responsible for market surveillance, investigation and prosecution of trading violations that occur on or through New York Stock Exchange (NYSE) systems, and listed company compliance. It protects investors through enforcing market-place rules and federal securities laws, as well as making sure all companies listed on the NYSE and NYSE Arca meet financial and corporate-governance listing standards. As well as running this operation, Ketchum is also chairman of the board of the newly created Financial Industry Regulatory Authority (Finra). NYSE Regulation merged its member oversight functions with NASD on July 31, 2007 to create Finra, the largest non-governmental regulator for all securities firms doing business in the US. It oversees nearly 5,000 brokerage firms, about 173,000 branch offices and more than 677,000 registered securities representatives. Finra is responsible for all member regulation oversight and also performs market regulation under contract for Nasdaq, the American Stock Exchange, the International Securities Exchange and the Chicago Climate Exchange. Achieving true integration following a merger can take a notoriously long time to complete but Finra is just about there. "The main aim of the merger was so we would have a single rulebook, a single set of interpretations and a single set of examinations," says Ketchum. "And we have made a good deal of progress over the past year. Both the examination and the enforcement teams have been pulled together and firms now receive a common examination. The last steps are completing all the technology efforts but it is working and they are operating as a single unit. The final step is creating a consolidated single rulebook, a task that will occupy the board's time into 2008." Having some 33 years' experience in the New York markets, Ketchum has witnessed a number of regulatory milestones that resulted in the modern market of today, from the introduction of compulsory publication of quote and trade information in the 1970s to the SEC's determination to allow electronic communications networks (ECNs) - now known as ATS or automated trading systems - to be able to compete without being required to be registered as exchanges. This opened up the market to true competition and the subsequent order display rule requiring customer orders to be displayed helped to integrate ECNs into the wider market. Aside from other smaller stepping stones along the way, and a much more recent development, Ketchum credits the implementation of Regulation NMS as a key regulatory milestone in the US. "There are many steps in between but another key milestone is Regulation NMS," he says. "The requirement for absolute routing to the best displayed price no matter where located essentially has moved the market from an environment where traders used judgement to decide how to best execute their orders to an environment where, for the most part, the execution of orders is driven by a very regimented requirement of taking care of the best quotes." Regulation National Market System (Reg NMS), which stipulates that a market centre is obliged to route an order to another exchange if a security is available elsewhere at a better price, was entered into the Federal Register in August 2005. It has significantly increased market fragmentation and has been a major spur to moving to more fully electronic trading, according to Ketchum. "There are many things about Reg NMS that are good. It has encouraged competition across exchanges in the US and because it effectively exempted dark pools from the requirements they have also continued to grow. I would say Reg NMS has been profound in the US. It has increased automated trading, encouraged even broader development of algorithmic trading, and increased competition and market fragmentation in the US. From a regulatory certainty and protection standpoint, it certainly has created an easier world to monitor and a world that works better for addressing abuse. But it is probably still a little early to come up with a final judgement on Reg NMS." Although he says that Reg NMS has helped improve market transparency, there is still a lot to do in the area of market surveillance particularly during this volatile period. "In other ways, the market is less transparent because of fragmentation," he says. "We have to be able to look across all trading and all markets to be able to really identify patterns and potential manipulative activity. Part of the problem is that dark pools often involve entities that aren't broker-dealers. So the first challenge is addressing transparency issues relating to dark pools. The second challenge is that not only do we have fragmentation nationally but we also have fragmentation internationally. We are not nearly in a position to fully address that yet." Ketchum is working closely with Finra and the SEC examination teams to try to identify situations where there is suspicious trading but he realises that effective surveillance in a global market needs better international co-operation. "We - NYSE Regulation, Finra and the SEC - cannot do this alone. Our markets in the US have become quite fragmented, as will occur in Europe in two to three years due to Mifid (the EU Markets in Financial Instruments Directive), and you can only get a good picture of what is going on to see trading on all exchanges. We need to make progress in co-ordinating our reviews with respect to European regulators. We have a natural interest in the effective exchange of information with Euronext, but it is equally as important with the London Stock Exchange given the central role they have in the market-place. "There is tremendous focus both with respect to the major European regulators and the SEC in trying to make this more effective. There is movement in a variety of areas. Part and parcel of mutual recognition is more fragmentation of trading across international borders, and the efficient handling and exchange of surveillance information is going to be an important partner to that type of mutual recognition. It is important that both in the US markets and externally exchange of information is seamless and extremely fast - we are not there yet but we hope to get there soon." Closer to home, market abuse detection and enforcement remains a key concern for NYSE Regulation. It is trying to build more controls into the system that will prevent violation of exchange rules. Ketchum worries about two types of market abuse in particular - insider trading, which includes trading in respect to corporate information but also with respect to market information; the second is market manipulation although sometimes they come very close together. "A third issue is the continuing effort to improve identification of serious violations of market integrity like insider trading," says Ketchum. "The fact that we continue to see the amount of incidences of apparent insider trading by relatively senior people in the securities industry just underlines the fact that we have to become more and more sophisticated in our ability to identify patterns and practices." Market manipulation remains a significant problem, as demonstrated by the recent spate of malicious rumours being spread about financial institutions by traders hoping to profit from the movement in the share price. But market manipulation can range from the classic issues of trying to manipulate stocks in connection with retail selling activities, so-called pump and dump schemes, to mini-manipulations concerning more active stocks where the security may be manipulated near the close to benefit or protect a firm that may have marking issues. "We try to build a variety of surveillances for both manipulation and insider trading that look at patterns in trading, instances where there is significant volatility, and concentrations of activity in a single firm. We have very detailed databases that try to connect individuals who may have been trading with any relationship to a financial transaction or financial firm to better understand where there may be abusive trading going on. "We have various requirements as to how orders that are supposed to be executed and closed are routing in and restrictions on proprietary trading when you have positions in the last few minutes of the day. We are building a variety of system blocks both with respect to how the specialists operate and people operating upstairs to protect against violation of the rules. From a surveillance point of view, it is really about continuing to get better at what we do: to identify more subtle patterns and practices. We now have much more ability to manipulate our information data with respect to identifying alerts and being able to pinpoint persons that may have been responsible for unusual trading on a number of occasions rather than looking at each alert as a separate item. That is both slow and cumbersome, and you are less likely to find the patterns. Sometimes you are looking for somebody who engages in a pretty gross manipulation at the close in multiple stocks to benefit an up-program trade or a range of positions that person has. Most of the time, with respect to insider trading or even manipulation, if somebody is abusing the system again and again they do so in an un-greedy way to ensure they are kept off the radar. A main part of what we are doing is more effectively shifting through data to identify patterns. Through the Intermarket Surveillance Group we are doing a better job of co-ordinating our reviews with other markets in the US, and through our own protocols co-ordinating with other markets in our Euronext brethren in Europe, to make sure that we are identifying situations." Each exchange in the US is a member of the Intermarket Surveillance Group, which has been expanded in recent years to make it more international. Any exchange in the world that has the ability to exchange information that is not blocked by privacy laws can become a member of the group. "This is the group that creates electronic systems to allow us to access each other's database when we receive suspicious trading alerts - so we can looking at the data on a consolidated basis." The volatility in the markets caused by the credit crunch has not only increased opportunities for abuse but it has also created a degree of regulatory uncertainty. Following the intervention of the Federal Reserve with JP Morgan's bail-out and acquisition of Bear Stearns, there is a great deal of deliberation over what changes in regulatory policy will emerge and how they will affect the self-regulation of exchanges. "There remains a lot of focus on regulatory policy issues - the World Federation of Exchanges regulation committee has recently offered a letter on the issue of mutual recognition in the US, as has Federation of European Securities Exchanges. So there is a good deal of tension on policy issues with regard to liberalising how intermediaries can co-operate across borders and how exchanges can provide direct access to trading entities cross borders. "On the Finra side, there is a huge focus on effective co-ordination with the Federal Reserve with regard to those firms that Finra has consolidated supervision of that are not part of a bank holding company. This is a new challenge on the other side of the Bear Stearns incident to make sure that the SEC, the Federal Reserve Board and, in a more minor way, Finra can provide support to ensure there is proper oversight on some of the risk issues in a pretty dicey environment." But regardless of the wider regulatory policy change that are threatening to emerge, the big challenges for NYSE Regulation will be to continue to increase information sharing among regulators within the more fragmented cross-border markets that now exist. "Over the next year there will be great focus on some of the issues relating to the credit crisis both from having a review of US capital standards and oversight and a hard look at some issues such as traders' valuations and how you increase their independence and increase accuracy. On the surveillance side, as abusers continue to become more sophisticated, particularly in insider trading and the use of more subtle market manipulation, efforts to ensure more efficient exchange of information need to continue so eventually we can get to a point where investigatory information can flow like water between self-regulatory organisations. We're not there yet, but we hope to get there soon." Biography Richard Ketchum is the chief executive officer of NYSE Regulation, and also serves as the non-executive chairman of the board of governors at the Financial Industry Regulatory Authority, formed from the 2007 consolidation of NASD and NYSE Member Regulation. Ketchum is also chairman of the World Federation of Exchanges' regulatory committee. Ketchum served as the first chief regulatory officer of the New York Stock Exchange since March 2004. From June 2003 to March 2004, he was general counsel of the corporate and investment bank of Citigroup, and a member of the unit's planning group, business practices committee and risk management committee. Previously, Ketchum spent 12 years at NASD and the Nasdaq Stock Market, where he served as president of both organisations. Prior to working at NASD and Nasdaq, Ketchum was at the Securities and Exchange Commission for 14 years, with eight of those years as director of the division of market regulation....
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