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By Jonathan Spicer
June 20, 2011 6:00 PM EDT
The cost of complying with new securities rules is making it harder for small and mid-sized U.S. brokerages to stay profitable -- and may force more mergers in the sector.
The market structure changes -- from short-sale restrictions to rules that stop trading in a stock when shares drop too steeply -- are keeping compliance and technology professionals buzzing at financial institutions engaged in equity trading, according to interviews with executives.
Small brokerages face other pressures, including declining trading volumes, but the need to stay on the right side of evolving laws in the high-speed marketplace has its burdens.
"Risk and compliance may be two of the bigger drivers of cost in all of the industry," said Bill Yancey, chief executive officer of Dallas-based Penson Worldwide's U.S. clearing operation, which has some 300 broker-dealer clients.
Yancey listed hardware, software, maintenance and surveillance as areas that evolve with the new regulations.
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"These costs of the layering on of regulation are adding up from an industry perspective, and the implementation side of it in most cases is pretty complex," he said.
Last year's "flash crash" brought about new rules that had long been debated at the U.S. Securities and Exchange Commission.
Among them is a ban on "naked" access, in which brokers rent out their access to stock markets to high-frequency traders that seek an edge through being able to buy and sell microseconds faster than others.
The naked access ban has prompted some high-frequency traders to convert into formal broker-dealers, while some existing brokers formed new BD units to secure additional licenses.
The ban is set to take effect July 14 but will probably be delayed, according to a person familiar with the SEC's thinking.
Aiming to stabilize markets or to eliminate advantages of some traders, regulators in the last 18 months also tightened short selling rules and adopted trading pauses known as circuit breakers, a scheme to be replaced by price limits.
The priciest change on the horizon is the SEC's proposed consolidated audit trail. This record of all trading activity was estimated to cost the industry $4 billion to implement, plus $2.1 billion in annual maintenance.
"Where we have a regulatory change that requires us to do something different with our business model, like add another broker dealer, we've had to do that, and that has increased costs modestly," said Alfred Berkeley, chairman of electronic institutional broker Pipeline Financial Services.
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