The main US markets watchdog has proposed the most sweeping overhaul of stock trading in almost two decades in an effort to improve prices and transparency for small investors.
Gary Gensler, chair of the Securities and Exchange Commission, said the measures outlined in more than 1,500 pages of documents on Wednesday would improve “competition and benefit both everyday investors and institutional investors”. But his plans led to resistance from market making firms that dominate the system.
Taken together, the proposals would produce the biggest changes to US equity trading rules since 2005, reshaping the business of executing deals for retail investors.
The most immediately contentious of the regulator’s proposed rules was a new auction mechanism that would force brokers to offer retail investor orders to a wider group of trading venues if they are less than $200,000.
Another proposal, on so-called best execution, would require brokers to document exactly how they had looked at venues to ensure they got the best price for their customers.
Currently, the definition of best execution is set by the Financial Industry Regulatory Authority, not the SEC.
“I believe a best execution standard is too important, too central to the SEC’s mandate to protect investors, not to have on the books as commission rule text,” said Gensler, a Democrat nominated by President Joe Biden.
The proposals have the potential to boost business for stock exchanges by allowing them to offer share prices in fractions of a penny, as off-exchange dark pools and wholesale traders already do.
Ronan Ryan, president of the IEX exchange, supported the reforms, calling them “a constructive and positive effort to improve transparency, increase competition, and ensure that investors can access the best prices available in the market”.
A surge in trading by retail investors in the early months of the coronavirus pandemic highlighted the practice of payment for order flow, in which retail brokers such as Robinhood were paid by big trading firms such as Citadel Securities to route customers’ orders to them.
While the practice helps brokers offer cut-price or free trading, the SEC fears it may not produce the best prices for clients. The regulator’s research estimates that small investors are out of pocket by as much as $1.5bn annually, or 1.08 cents per $100 traded, because of what it describes as a “competition shortfall”.
Gensler said that in September, off-exchange trading accounted for 42 per cent of all equity dealing volume. Earlier data showed that this share was roughly a third in 2009.
While the SEC’s proposals would not ban payment for order flow, they would likely make it far less appealing for brokers and wholesalers alike. Shares of Virtu Financial, a New York-listed trading firm, fell 6.4 per cent on Wednesday. Virtu declined to comment.
Citadel Securities said: “The US equity market is the envy of the world, and any proposed changes must provide demonstrable solutions to real problems while avoiding unintended consequences that will hurt American investors.”
A majority of the SEC’s five commissioners voted in favour of each of the proposals, but two voted against the auction and best execution plans. Hester Peirce, a Republican commissioner, said the regulator “has a habit of trying to micromanage the markets, a habit I believe is on full display today.”
The proposals will be open for comment until at least March 31. Steve Sosnick, chief strategist at Interactive Brokers, predicted “very strident” reactions from many groups. “You’re screwing around with people’s business models,” he said.
Gensler said reform was needed. “The markets have become increasingly hidden from view, especially for individual investors,” he said. “This is in part because there isn’t a level playing field among different parts of the market: wholesalers, dark pools and lit exchanges.”
Separately, commissioners began Wednesday’s meeting by approving a final rule that will force company executives to wait 90 days to sell shares after establishing so-called 10b5-1 plans, which are designed to enable automatic stock sales that adhere to insider trading rules.
The 90-day period would end a controversial practice in which executives sell stock days after creating a plan, raising suspicion that they may have acted with inside information.
Peirce also raised concerns about some details of the insider trading reforms, but said they would “do more good than bad” and allow insiders “to trade without fear of liability while making it more difficult to misuse the rules”.
