Investors join opposition to SEC stock market reforms

Several big investors have joined opposition to an ambitious stock market overhaul proposed by US regulators to improve transparency and pricing for smaller retail traders.

The criticisms point to deep concern about elements of plans published in December by the Securities and Exchange Commission and promoted by chair Gary Gensler which amount to the biggest reform of equity trading in two decades.

The regulator’s focus on the innards of stock trading follows the explosion in consumer interest during pandemic lockdowns. That produced the 2021 “meme stock” frenzy which collapsed in acrimony after overwhelmed brokers limited trading in several companies.

The SEC’s proposals to increase the data brokers publish and to shrink trading increments has gathered some support, albeit with suggested changes. The increments or “tick size” rule would allow stock prices to move up and down by less than a penny and in theory would improve pricing for the most in-demand stocks.

But more controversial is a plan to introduce its own “best execution” regime — mandating brokers to make all efforts to find the best price for investors — on top of similar standards that are already in place.

The SEC also wants to force brokers to auction retail investor orders to a wider group of trading venues in a rebuff to the practice of “payment for order flow”. PFOF enables retail-focused brokers such as Robinhood to offer “free” trading to customers as market makers like Citadel Securities pay them to execute their orders.

The SEC’s ideas have stirred fierce debate among market participants over their potential impact. Comments on the proposals were due on Friday.

While retail brokers and market makers were expected to resist the proposals, which could threaten their current business models, several big fund managers are also sceptical that end users of the markets would benefit as the regulator intended.

Kenneth Bentsen, head of finance industry association Sifma, called on the SEC to study the extra data that would be collected under the most broadly supported proposal before deciding whether its more ambitious plans would benefit investors.

“We respect the SEC’s role as a policy and rulemaker, but it is acting very rapidly and largely on theory — and that could bring risk into the system,” he said. “Congress has looked at equity markets pretty closely in the last two years and its recommendations didn’t come close to what the SEC is proposing.” 

Sifma’s asset management arm has submitted a separate letter that also questions the value of the auction rule and of adding another best execution rule. Others to have raised issues include Fidelity, BlackRock. State Street Global Advisors, T Rowe Price and UBS Securities.

“We are concerned with the prescriptive nature of the proposal and believe that it does not clearly benefit retail investors and may disadvantage them,” said Fidelity. The fund manager is not involved in PFOF.

Line chart of Robinhood and S&P 500 price returns (%) since the broker's IPO showing Post-IPO slump

Retail trading reached record levels earlier this year, accounting for almost a quarter of all market activity on some days in late January according to JPMorgan analysts. The orders are considered particularly valuable.

The largest stock exchange groups have also raised concerns despite being the intended beneficiaries of some of the proposals. Exchanges have lost substantial market share to less heavily regulated groups such as Citadel Securities over the past decade, and Gensler has been vocal about his desire to reverse the trend.

Yet in its response to the SEC’s plans, the New York Stock Exchange teamed up with Citadel to voice its concerns. Although they are competitors, Citadel Securities is also a key client of the NYSE and its parent group Intercontinental Exchange.

In a letter that was also cosigned by Charles Schwab, the largest retail brokerage, the NYSE and Citadel Securities urged the regulator to withdraw the auction and best execution proposals, and to significantly water down the others.

They also requested the commission reconsider some previously agreed changes that were designed to increase transparency and would have been sped up under the most recent proposals.

NYSE rival Nasdaq was less critical, but also called for a more “incremental and pragmatic” approach. It said the regulator’s focus on auctions to improve competition for retail investors was risky, and warned there was “no silver bullet solution.” 

Its most vigorous criticism was targeted at the SEC’s plans to cut the fees that exchanges can charge for trading against their quotes. Nasdaq and NYSE use the fees to pay for rebates to other market makers and increase liquidity.

Nasdaq said “it would be arbitrary and capricious for the commission to proceed with the proposal in the absence of evidence that the current fee cap is actually harmful”.

However, not all exchanges were opposed. Brad Katsuyama, chief executive of IEX — which does not rely on rebates — said: “It has been nearly 20 years since the last major regulatory change in the stock market, making it hard to argue that modernising outdated rules will be bad for investors.” 

The SEC is expected to take time to review the comments before deciding what amendments, if any, to make.