Naked short sales and credit default swaps already have a bad rap in Washington; now another form of "naked" trading has fallen into disrepute.

In January the Securities and Exchange Commission proposed to ban "naked," or "unfiltered," access -- arrangements that allow regulated broker-dealers to lease their access to the exchanges to unregulated clients.

"Unfiltered access is similar to giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied," SEC Chairwoman Mary Schapiro said when the proposal was unveiled at the beginning of the year. "If a broker-dealer is going to loan his keys, he must not only remain in the car, but he must also see to it that the person driving observes the rules before the car is ever put into drive."

With 38% of all U.S. stock trading done by firms that have "naked sponsored access" to markets, the SEC wants to require broker-dealers with market access or those that provide market access to others to keep effective pre-trade risk management controls and supervisory procedures in place.

Regulators' concerns about naked access were heightened following the 1,000-point market dive on May 6, and they are currently looking at whether the practice played a role.

The problem with naked access, says the SEC, is that neither the exchanges nor the regulators know who is actually submitting an order if it comes direct through a broker's market access gateway. And if that order is being created by a black-box algorithm, the SEC feels that the onus should be on the broker to prove that all orders are going through pre-trade risk check filtering.

Specifically, the proposal would require broker-dealers that control the trading gateway and any leasing parties to implement risk controls and supervisory procedures to manage various risks, such as orders that exceed credit and capital thresholds. The controls would have to be applied on a pre-trade basis, or before orders are routed to an exchange, under the SEC's proposed rule. Brokerages would not be allowed to outsource their supervisory procedures to third parties and would have to document and regularly review their risk management controls and procedures.

The comment period for the SEC's proposal on sponsored access ended in March. Comment letters for the most part favored the proposal's position that unfiltered, or "naked," sponsored access should be abolished. Adoption of the proposal could come any day.

However, firms that provide naked access, such as U.S. equities exchange Bats Exchange Inc., say that while they generally support stronger oversight, the proposal could have unintended consequences. "The proposal is too far-reaching in its scope and ... will have the unintended consequence of dramatically increasing trading friction and, ultimately, trading costs, which will in turn reduce available liquidity with little added benefit towards enhancing risk controls and preserving the integrity of the financial system," wrote Eric Swanson, senior vice president and general counsel of Bats Exchange, in his firm's submission to the commission.

Bats argues that the risk controls required by the SEC's proposed rule should be imposed by the broker-dealer originating the order, as otherwise any broker that subsequently touched the order would have to impose its own risk controls.

Others are concerned that equity market liquidity could be compromised if the U.S. imposes stricter sponsored access controls on its own. But the SEC and others in the industry fear that an unsupervised account without proper safeguards could blow up the market. The concern is that if a wrong keystroke is accidentally entered, or a high-frequency trading firm doesn't have the proper credit, trades won't clear.

However, the Financial Industry Regulatory Authority, or Finra, the securities industry's in-house regulator, argues that the proposal should indeed be applied to all broker-dealers that obtain sponsored access. Marcia Asquith, a senior vice president and corporate secretary of Finra, in her firm's submission, said that "Finra believes such obligations should continue to apply to both the sponsored and sponsoring firms under the SEC's proposal."

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Donna Block covers the Securities and Exchange Commission for The Deal.