(Article from Registered Funds Regulatory Update, July 2022)
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In a recent speech, SEC Chair Gary Gensler addressed possible regulatory changes intended to address the “uneven playing field” resulting from the increasing role that private securities exchanges, or “dark pools,” and wholesalers are playing in executing retail trades and potential changes to the national market system rules tailored to address concerns of competition and fairness.
Gensler identified six areas in which he has directed the SEC staff to examine and make recommendations on potential rule changes for the SEC Commissioners to consider.
Minimum Pricing Increment. Gensler asked the SEC staff to propose rules harmonizing the minimum pricing increments (i.e., the “tick size”) across market centers in an effort to address concerns of competition and fairness. Gensler noted that retail investors typically trade in exchanges based on prices in one-penny price increments, while wholesalers can fill orders in off-exchange venues using sub-penny prices. Specifically, he asked the SEC staff to make recommendations to ensure that trading occurs in the minimum tick size or to shrink the minimum tick size to better align with off-exchange trading.
National Best Bid and Offer (NBBO). In an effort to increase pre-trade transparency for retail investors, Gensler asked the SEC staff to consider changes to the calculation of the NBBO. The NBBO aggregates the highest and lowest bid ask prices for a security across exchanges to provide a bid-ask spread for investors before they trade. The current NBBO calculation rules only include round lots, or quotes for trades of 100 shares or more, and excludes quotes for all other “odd-lots,” which also tend to be traded by retail investors. Gensler suggested that the SEC accelerate the implementation of the Market Infrastructure Rule, adopted by the SEC in 2020 and recently upheld in Court, which expands the definition of round lots and adds odd-lot information to core market data, and asked the SEC staff to consider whether there should be an NBBO quote for odd-lots.
Disclosure of Order Execution Quality. Gensler stated that enhanced disclosure would enable investors to better compare broker execution quality. Specifically, Gensler asked the SEC staff to consider subjecting broker-dealers to Rule 605 of Regulation NMS reporting requirements, which currently mandate “market centers” (e.g., dark pools, wholesalers, and exchanges) to provide standardized reporting on order execution quality. Further, Gensler asked the SEC staff to make recommendations to require all Rule 605 reports to provide additional data on execution quality, such as the price improvement as a percentage of the spread.
Best Execution. Gensler raised the possibility that the SEC could implement its own requirements for broker-dealers to exercise reasonable diligence in executing orders. Gensler referenced both FINRA’s and the MRSB’s already existing best execution rules but asked the SEC staff whether the SEC should consider its own best execution rules to provide more detail around the procedural standards brokers must meet when handling and executing customer orders.
Order-by-Order Competition. Gensler cited 2022 data that over 90% of retail marketable orders were routed to wholesalers that pay for the right to execute order flow. Gensler suggested that this practice leads to economic rents for wholesalers, and asked the SEC staff to examine whether a range of options, such as requiring stock auctions whereby trading firms compete on an order-by-order basis based on the best price, might better benefit retail investors.
Payment for Order Flow, Exchange Rebates, and Related Access Fees. Gensler noted that payment for order flow, exchange rebates, and related access fees can create conflicts of interest if they affect the prices and practices of brokers, thereby distorting their routing decisions. Gensler did not call for a ban on these practices, as some of them may benefit retail investors (e.g., enabling brokers to provide commission-free trades), but he asked the SEC staff to identify how conflicts of interest could be mitigated. Gensler noted that increased disclosure about exchange fees and rebates and harmonizing minimum price increments could potentially allay these conflicts of interest.
Gary Gensler, SEC Chair, Speech, “Market Structure and the Retail Investor:” Remarks Before the Piper Sandler Global Exchange Conference (June 8, 2022), available at: https://www.sec.gov/news/speech/gensler-remarks-piper-sandler-global-exchange-conference-060822.