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Hey, SEC committee: Don’t be fooled. Put investors first

The SEC finally announced the members of their Equity Market Structure Advisory Committee, ending a more than six-month long wait to see who will advise the regulators as they tackle the issues facing our markets. This panel of experts, a who's who among the trading community from Wall Street to academia, will review the way our equities markets work — and don't work — and hopefully produce a solid blueprint for moving forward.

What should that blueprint look like?

That may be a tougher question to answer than you think.


A trader works on the floor of the New York Stock Exchange.
Getty Images
A trader works on the floor of the New York Stock Exchange.

The problem is that most of the easy problems have been solved already. Today's equity markets, while far from perfect, are still the best in history and the best in the world: it's never been cheaper, safer, or, of course, faster to execute a trade.

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However, we still face problems, difficult problems, in our markets: market fragmentation (do we really need more than forty distinct venues for trading stocks?), off-exchange trading (would some of the trades negotiated away from the public exchanges be better served on the public exchanges?), information disclosure and transparency (do you know how, why and by whom your orders are handled?), and the role of technology (can the consolidated market service, the SIP, be made faster and more reliable?).

Any "solution" to the hard problems will create winners and losers. That's not necessarily a bad thing, but such decisions shouldn't be made lightly. They need to be well reasoned, based on solid data, and include a mechanism for monitoring their ongoing effectiveness. Most of all, they need to serve the general public and not just the most vocal special interests.

For example, even the most fervent believers of last spring's "Flash Boys" conspiracy theory should admit that their unsubstantiated claims of front-running actually had nothing to do with retail investors, but instead were the complaints of a handful of brokers and hedge funds unhappy with the results of their trades in the markets. Murkier still was the question of how their proposed "solutions," tilting the balance in favor of these selected Wall Street interests, would help — and not harm — retail investors.

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It's not really surprising that most proposals boil down to Wall Street firm A jockeying for advantage at the expense of Wall Street firm B – and anyone else who gets in the way. But if we have to choose winners and losers, let's just be sure that someone is carefully vetting every "solution" to understand exactly who is impacted (and how). Our retirement savings shouldn't be collateral damage in some intra-Wall Street skirmish.

Of course, tradeoffs are inevitable as the committee tackles the hardest problems of market fragmentation and the role of off-exchange trading. Absurd as it may sound, though, some are pushing to shoot first and ask questions later. I'd prefer to gather data first, understand it, and then consider whether or not to pull the trigger.

In this vein, an obvious win-win proposal for the committee will be to improve information disclosure and transparency around dark pools and order-handling practices. Current disclosure requirements about how, why and by whom retail and institutional orders are executed need a serious overhaul. Not only will all investors benefit from more detailed reporting on order handling, but the best brokers will benefit as well.

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Many brokers are incredibly sophisticated and savvy about how they achieve the best executions for their clients, yet the existing regulatory reports provide little opportunity for quantifying this. More detail will help customers separate the all-star brokers from the bench-warmers.

Such detailed data will also provide the foundation for intelligently addressing market fragmentation and the role of exchange trading. Knowing where, why and how trading occurs is a prerequisite to writing rules to change it.

The other obvious win-win proposal is to invest more in public infrastructure technology, like the consolidated market data services. While there will be some debate on who pays for this, the costs are peanuts in comparison to the benefits – and Wall Street's profit margins – and no one can seriously complain if the costs are spread broadly.

In the end, the committee may rightly conclude that what our markets need right now is not radical change, but rather thoughtful, incremental change likely to improve markets for investors. And if they have to choose winners and losers, let's make sure that investors end up in the winners' column.

Commentary by Peter Kovac, author of "Flash Boys: Not So Fast," and a former high-frequency trading executive.