SEC Chair Gary Gensler tees up changes to how the stock market operates

Published Tue, Dec 13 20229:20 AM ESTUpdated Tue, Dec 13 202210:03 AM EST

The SEC will hold a meeting tomorrow to consider several proposals, including an effort to get better prices on trades for small investors. It's part of an overhaul of market structure that SEC Chair Gary Gensler hinted at in June, when he suggested that the playing field was not level for all investors. "It's not clear, with such market segmentation and concentration, and with an uneven playing field, that our current national market system is as fair and competitive as possible for investors," Gensler said at a Piper Sandler conference on June 8th. But some of Gensler's proposals are likely to be met with broad opposition from market participants. Getting better prices for small investor trades Gensler has been critical of payment for order flow (PFOF), whereby some retail brokers (including Schwab, ETrade and Robinhood) route orders to electronic market makers known as wholesalers, who pay the brokers for access to that order flow. These wholesalers may send the orders to exchanges, but often match the orders against their own internal order flow. The wholesalers profit from the difference between the buying and selling price. The fees brokers receive have allowed brokers to charge zero commission to their clients. However, Gensler has claimed that pension funds and other institutional investors are not able to interact with that retail order flow. He also claimed the brokers are putting their financial gain ahead of their requirement to provide the best prices to their clients. Brokers and wholesalers (including the two largest, Citadel Securities and Virtu) have vehemently disagreed. To increase competition, Gensler is floating the idea of setting up auctions in which trading firms would compete with each other to fill investors' orders before they could be executed internally. Minimum pricing increments Under current regulations, exchanges such as the NYSE and Nasdaq cannot take orders at anything less than a penny increment, however dealers internalizing their orders can trade in sub-penny increments. The SEC may be considering creating a minimum uniform trading increment. For example, it may consider allowing trading in increments of a half cent, or even a tenth of a cent, for all market participants. Reduce access fee cap Exchanges charge fees to access their trading systems. Gensler is considering a proposal to reduce the fees that are being charged in an effort to increase order flow to traditional, "lit" exchanges . Execution quality disclosure Market participants are required to submit monthly reports indicating how well they are executing client orders. Gensler has also been critical of this rule, known as Rule 605, noting that the requirements have not been updated since 2000. Gensler has said investors today need a better understanding of how well their trading orders are being executed. Best execution In addition to more information on how well firms are executing orders, Gensler is proposing a new rule, Regulation Best Execution, that would establish a national best execution standard to ensure broker-dealers send orders to the venue that will get the best price for buyers and sellers. More disclosure for insider trading plans Separately, the commission is also considering beefing up disclosure requirements for corporate insiders who want to sell their own stock. Rule 10b5-1 allows corporate insiders (CEOs and other high-ranking officials) to set up a trading plan for selling stocks. It allows insiders to sell a predetermined amount of stock at a predetermined time to avoid running afoul of insider trading laws. "It looks like the Commission is going to beef up requirements for 10b-5 plans to make them more transparent for the public (as these are filed with the SEC), perhaps more restrictive as well, and add new reporting requirements," Amy Lynch, President of FrontLine Compliance, told me. What will happen? These are proposed rules. The Commission will likely vote on party lines (3-2) to approve the proposals, but they will face a lengthy review process to get across the finish line. How lengthy? "We believe the disclosure changes could take up to two years to finalize...we don't see how these policies are adopted before Memorial Day 2024," Jaret Seiberg from Cowen Washington Research Group said in a note to clients. Seiberg noted that there is far less pressure on Gensler to act on these proposals than there was a year and a half ago. "Capitol Hill interest in market structure has faded since the GameStop controversy," he said. "Congress is now fixated on crypto." Indeed, the SEC today charged Samuel Bankman-Fried with orchestrating a scheme to defraud investors in FTX Trading. Others disagree, noting that Gensler has been dogged in pursuing his agenda this year and that he is unlikely to be dissuaded. "You will likely see a 45-60 day comment period, and then the Commission will likely adopt the market structure rules in 2023, and then if they [the securities industry] want to challenge it, go ahead," one market participant, who asked to remain anonymous, told me. Are retail investors being disadvantaged? While several of the proposals have industry support, others — particularly the proposals on payment for order flow — are already encountering significant pushback from Republicans and many in the trading industry. Rep. Bill Huizenga (R-Michigan) and Rep. Josh Gottheimer (D-N.J.), both members of the House Financial Services Committee, sent a letter to Gensler last week saying that today, "retail investors enjoy better prices, increased liquidity, and in many cases, no transaction fees." They argued that making changes of this magnitude, particularly introducing an auction system, could result in "unintended consequences" and urged a broad cost-benefit analysis. Jim Toes, president of the Security Traders Association, an industry trade group, said that introducing a regulatory designed auction mechanism was "a new and radical concept" and that STA thinks "that a typical comment period of 60 or even 90 days will not be enough time to provide meaningful input." Larry Tabb, Director of Market Structure Research at Bloomberg Intelligence, told me it's not clear if investors would get better prices under an auction system, nor is it clear investors are being disadvantaged under the current system. "Looking at the numbers, it looks like the customer is getting a really fair shake," Tabb said. "Not only do they get a deal on the most actively traded stocks, they get a good deal across the spectrum, even the low-priced, low volume stocks." Tabb noted that in the last several decades bid-ask spreads have declined, execution speed has improved and fees have declined. Gensler's broad agenda The proposals on market structure are part of a broad agenda Gensler has undertaken this year. More than 50 rules have been floated, some of which are in the proposal stage, while others are in a Final Rulemaking Stage that could be adopted shortly. These proposals include climate change disclosure, pay vs. performance, climate change disclosure, cybersecurity risk governance, share repurchase disclosures, money market fund reforms, short sale disclosure reforms and loan or borrowing of securities. If there is a single theme emerging from the SEC under Gary Gensler, it would be that he is seeking many new rules that would provide increased disclosures on everything from climate risks to private equity. Gensler believes this would increase market transparency. "In any case, it looks like firms will be burdened with additional reporting and documentation to show they are following written policies and procedures," Lynch of FrontLine Compliance told me.