The New York Stock Exchange finds itself at odds with major pensions and some of the world's biggest asset managers in a fight to preserve a big way exchanges attract business.
At issue is the Securities and Exchange Commission's plan to run a pilot test of how the stock market is affected by the transaction fees and rebates that exchanges use to attract trade orders from brokers.
The thinking is these fees and rebates, now common across the U.S. stock market, actually distort how stock trades are handled, costing investors money. The SEC plans to see how lowering the fees and rebates for trading in some stocks changes things.
Just how much money is at risk is difficult to say. If it's true that investors are getting a worse price for their trades with the rebates in place, it would amount to fractions of a penny, perhaps. But over a long period of time and a big number of trades, those pennies add up.
It's the type of inside Wall Street squabble that mom-and-pop investors would normally ignore, if they knew about it at all. But maybe they should pay attention, says Linda Giordano, the co-founder and CEO of BabelFish Analytics, a company that advises mutual funds about their trading. "You need to care about the pennies."
The SEC's test has been a long time in the making, and the exchanges are fighting back at what they see as an attempt to undermine a big business. Exchanges make money off the trading data they sell to brokers in addition to the technology services they offer to facilitate speedy trading. The more trading volume they attract, the better.
Long-term investors have to compete in this environment with short-term traders looking to make a profit off tiny price moves multiple times a day. Critics say the transaction fees and rebates only motivate brokers to send their trades to the place that will give them the biggest rebate or the lowest fee, not where they could get the best price for customers.
Giordano from BabelFish said their observation was that two-thirds of passive routes to an exchange on behalf of investors are made with the rebate in mind. And ClearPool, which designs computer trading models, found that orders placed to get the rebate were seven times more expensive to investors than those placed with a neutral attitude toward the rebate.
Major pensions such as the California Public Employees' Retirement System and Ontario Teachers' Pension Plan have come out in support of the SEC's pilot test, as have giant asset managers such as Vanguard and BlackRock. The agency took in public comments in the last few months before the test is set to begin.
"The model creates the appearance of a conflict between broker-dealers and their customers, as firms may appear motivated to route an order to a specific exchange to realize a higher rebate or a lower fee," Vanguard's Joseph Brennan, the global head of equity investment group, wrote in a comment letter.
But the NYSE, which is owned by the Intercontinental Exchange, has come out swinging, arguing that the SEC's test itself will be too disruptive and potentially cost investors more than $1 billion. High-frequency trading firms and The Security Traders Association of New York have weighed in with the same concerns, urging the SEC to scale down the test, including eliminating exchange-traded products.
The STANY wrote in a recent comment letter, "[T]he Pilot will likely cause serious disruptions to the market, have significant implications for investors and impose industry-wide costs that have not been justified."
What's more, the NYSE contends, companies listing their stock on exchanges would also be harmed by the test, which is set up so that 3,000 stocks will be sorted evenly into one of three categories, each with a different set of fees or rebates, to see how different transaction pricing affects them.
The NYSE sent a notice to companies urging them to send a comment letter to the SEC about the test. "The pilot may also disadvantage companies selected for one of the test groups while their peers or competitors could escape that fate," said the notice, which was reviewed by CNBC. "As currently envisioned, it does not appear that companies could opt-out."
That is exactly something the pensions have asked the SEC to preserve in the test. "In order to maintain the integrity of the pilot, companies should not have the option to opt out," Kevin Duggan of the Ontario Teachers pension and Don Pontes of CalPERS wrote in their comment letter.
The broader issue is whether investors are getting a fair shake in the markets, which have become dominated by computerized trades zinging in and out of positions in milliseconds, not to mention a dizzying array of index-tracking funds. That won't be answered by the SEC's test, which is just looking at gathering enough data over a proposed two-year period to decide which way to proceed.
"Rather than rule-making by a hunch, we can actually figure out whether it's right," said Georgetown University finance professor James Angel. "That's why we need a pilot."