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 agency’s focus on the inner workings of the US stock market was revived after pandemic lockdowns prompted an explosion of activity from consumers.
That culminated in the dramatic surges in the prices of popular so-called meme stocks, such as GameStop and AMC, last January — and the imposition of temporary trading restrictions by some brokers to stop more investors from piling in. The halts in trading drew fire from politicians in Washington.
The most immediately contentious of the regulator’s proposed rules is 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 received 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, just 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”.
The meme stocks incident highlighted the practice of payment for order flow, in which big trading firms such as Citadel Securities and Virtu Financial buy the customer orders of retail brokers such as TD Ameritrade and Robinhood, rather than go directly to the stock market.
While the practice helps big brokers offer retail investors cut-price or free trading, the SEC fears it may not lead to the best deals 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 from 2009 showed that this share was roughly a third.
While the SEC’s proposals would not ban payment for order flow, they would probably make it far less appealing for brokers and wholesalers alike.
Citadel Securities, the market’s largest market maker, 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.”
Shares in Virtu, the second-largest group and a vocal opponent of Gensler’s planned reforms, fell 6.4 per cent on Wednesday. Virtu declined to comment.
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 added. “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”.