The SEC adopted new Rule 13h-1 as a response to the Flash Crash of May 6, 2010.  Broker-dealers, traders and clients are now responding to the rule's burdensome requirements and unanswered questions.

Rule Requirements.   The rule contains the following requirements:

    1.  Filing a Form:  Traders who engage in a substantial level of trading activity must identify themselves by filing new Form 13H with the SEC.  A “large trader” will be defined as a person whose transactions in exchange-listed securities equal or exceed 2 million shares or $20mn during any calendar day, or 20mn shares or $200mn during any calendar month.  The rule provides guidance on certain types of transactions that can be excluded for purposes of calculating trading levels.

    2.  Getting an Identification Number.   After receiving Form 13H from traders, the SEC will assign each large trader a unique large trader identification number ("LTID"), which will allow the SEC to efficiently identify and analyze trading activity by the large trader.  A large trader must disclose to its B/D's its LTID and highlight all of the accounts at the B/D through which the large trader trades.
 

    3.  Recordkeeping, Reporting, and Monitoring.   Broker-dealers must maintain and report data that is largely identical to the information covered by the SEC's Electronic Blue Sheets (EBS) system, that the Commission currently uses to collect transaction data from B/D's.  The only additional items that B/D's will be required to maintain and report are the LTID and the time a transaction occurs.  As such, the rule leverages the existing EBS system, with modifications, to accommodate the specific requirements of the new rule.  In addition, the rule requires B/D's to monitor whether their customers meet the threshold levels that define a “large trader” - based on transactions handled at the B/D - in order to encourage compliance by their customers with the requirement to identify themselves as large traders to the SEC.

    4.  Ready Access to Data.   Transaction data must be available for reporting on the morning after the day the transactions were effected.  When the SEC requests data from B/D's, it would not under normal circumstances require responses earlier than the opening of business on the day after it makes its request. 

Concerns on the Street with Large Trader Identification Number.   Main concerns center around these areas:

Broker Routing and Client Anonymity.   This is a primary area of concern for clients - i.e., there's increased risk of information leakage. 

• Will the unique client tag need to be passed on when brokers route client flow to other brokers?   
• If a broker routes a portion of a client’s order to another broker-owned dark pool, for instance, will the order have to be tagged with the client's unique LTID?
• If so, what could be done with this information at the B/D? 
• Who would have access to such information and how might it be used?

Security of the Information Collected.  Who at the SEC will have access to, and be able to see, this data?

• What, if any, safeguards exist to ensure that those people with access to the cross-broker transaction records of major U.S. institutions won't retain that information when, say they leave the SEC for the private sector.
• Might someone be able to reverse-engineer clients' strategies from this data?
• Is there any way for this information to remain strictly within the SEC and not accessible to others?  e.g., if the SEC were presented with a subpoena in criminal proceedings, would the SEC be obligated to provide the data?

Additional Burdens on Clients.  

• Complex firms, especially those with hundreds or thousands of affiliates, will find large trader reporting extremely difficult.  Those dealing with many affiliates will find that the obligation to identify a parent company and provide a list of accounts over which affiliates exercise investment discretion be extremely labor and time intensive.
• Those firms that have never been have registered with the SEC now will face a brand new experience and might easily become overwhelmed by the daily reporting requirements. 
• Clients may begin to see or experience increased regulatory scrutiny now that they're providing T+1 (next day) trade data, as opposed to the current longer lead times. 

From the ICI's Perspective.   In a comment letter submitted to the SEC, the Investment Company Institute said:  "As proposed, however, new Rule 13h-1 and Form 13H raise significant concerns relating to the burdens and costs of developing and operating a large trader reporting system that would be imposed upon investment advisers to registered investment companies that would qualify as large traders."

There are other concerns and questions that need to be addressed - beyond those noted above.  C-I will report tomorrow on the SEC's schedule for implementing the rule.