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11 March 2013- Police departments have crime scene investigators to collect evidence. The Federal Bureau of Investigation’s behavioral analysis unit helps solve violent crimes using psychological analysis.

And now …

The Securities and Exchange Commission (SEC) … the US financial watchdog … has joined the fray with a quantitative analytics unit to monitor the algorithmic trading strategies that hedge funds and other trading firms are increasingly deploying.  Erozan Kurtas, head of the SEC’s Quantitative Analysis Unit (QAU) has been popping up at all manner of securities law and tech events, usually at the SEC’s series of national seminars.  To get a feel of his focus here is a piece he presented last year “Convergence of disciplines: Rise of the Algorithms” (click here). He was recently quoted in an SEC press release stating “the use of quantitative techniques and computer-driven algorithms has changed the market structure and financial world drastically in the past decade. It provides a lot of challenges to regulators and companies.  If you look at many of these companies, I don’t see them as solely finance companies, I also see them as engineering companies driven by algorithms”.

NOTE:  Kurtas holds a PhD in electrical and computer engineering and more than 20 patents on algorithms and statistical techniques, joined the SEC in 2010 as a senior examiner. He previously worked at a hedge fund and Standard & Poor’s analyzing structured products. Last Spring, the SEC brought him in to run the QAU as part of a broader effort to tackle the new fast-developing electronic world of trading, which came under the spotlight as a result of the 2010 “flash crash” that whipsawed US stocks. Caught flat-footed by that episode, the SEC created a risk division, also staffed with quantitative analysts, to focus on broader market trends. The QAU is meant to work as a group of field agents who deal directly with the trading firms.

The unit is part of the SEC’s examination program and is staffed with PhDs who have spent on average more than a decade in the industry building trading systems, statistical analysis and models.

It was launched last spring out of a need to understand better and respond to the rapidly changing computer-driven strategies that dominate the modern market and present compliance and regulatory challenges. The staff’s technical knowledge is being shared within the agency and externally, including at recent meetings with the FBI, to highlight risks and potential areas of market manipulation.

And it was obviously driven by all the critics and pundits who say that computerized trading can undermine investor confidence. Some fear it can exacerbate wild swings in individual stocks and the equity market. Supporters say it provides depth to the markets, which helps reduce volatility. Regulators, for their part, are finding such trading is developing at a pace that outstrips the knowledge of many of the market gatekeepers and raises the risk of manipulation.

Kurtas has referred to his team as “Jedis” (hence the graphic above) in a reference to the lightsabre-toting knights in the Star Wars films.  The team meets regularly with hedge fund compliance officials to analyse trading strategies.

And … SURPRISE! .. not everyone is happy about this. Some companies are reluctant to share their proprietary formulas with government officials whom they fear could leave and join businesses where the strategy could be used to their advantage.

The take from Kurtas: the SEC needs to know the new things coming up, which ones may pose potential risks to the market as a whole,  to be helpful to investors.

And as we learned at a recent compliance officer workshop in London, some firms are a bit lopsided on all this tech with their technological innovation outpacing the ability of the companies’ compliance teams to police it. Compliance officials generally have a legal background but lack the financial engineering expertise to build systems to oversee automated trading.

Tags: algorithmic trading strategies, Erozan Kurtas, quantitative analytics unit, Securities and Exchange Commission (SEC), SEC’s Quantitative Analysis Unit (QAU), use of quantitative techniques and computer-driven algorithms | Category Technology and Big Data

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