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SEC's Peirce: Are Equity Market Structure Rules Outdated?

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The central role of government in designing the equity market structure seems a bit outdated, according to a recent speech given by SEC Commissioner Hester Peirce.

Peirce, who was appointed by President Donald Trump to the Securities and Exchange Commission and was sworn in on Jan. 11, was a keynote speaker at the SIFMA Equity Market Structure Conference in New York.

In her speech, Peirce looks back to the enactment of the Securities Acts Amendments of 1975. She does this “to understand why — perhaps uniquely among American marketplaces — every interaction of participants in the U.S. equity markets is carried out according to specifications either mandated or approved by the Commission,” she says.

When enacted, the ’75 Amendments represented an “ambiguous mandate” to the SEC, according to Peirce.

“On one hand, they instructed the Commission to remove barriers to competition in the equity markets,” she said. “On the other, they directed the Commission to manage that competition consistent with the public interest.”

Peirce explains that the central mandate of what would become Section 11A of the Exchange Act — that the Commission “facilitate the establishment of a national market system” — was “capacious enough to accommodate either an industry-centered or a Commission-centered reading of the amendments.”

However, other parts of the statute were less ambiguous. According to Peirce, the ’75 Amendments extended an invitation to the Commission to involve itself in micromanagement of market infrastructure and interactions.

As Peirce explains, the exchanges saw their activity subject to extensive scrutiny by the SEC, which gained the authority to approve or disapprove SRO rule changes and to change or abolish those rules. The SEC also was given “pervasive rulemaking power to regulate all organizations engaged in the business of collecting, processing, or publishing information relating to quotations for and transactions in securities.”

According to Peirce, some say that this “generous grant of authority” to the SEC was justified given evident market failures.

“After all, the equity markets had manifested obvious and severe deficiencies in the late 1960s and early 1970s; a small number of markets dominated equity trading and resisted the publication of quotes or trading data; and linkages between the markets ‘were primitive or even nonexistent,’” she explained.

However, Peirce said that it’s not at all clear to her that the expansive role for the SEC mandated by the ’75 Amendments was warranted by these challenges confronting the equity markets at the time.

Nor, she added, is it clear to her that “such a role continues to be warranted in the very different markets that have developed over the intervening 43 years.”

However, Peirce does note that others argue that — given the then-dominance of the New York Stock Exchange in particular — price competition would never have developed on its own and competition alone would not have forced exchanges to improve transparency and establish linkages with other markets.

Peirce does admit that any imminent repeal of the ’75 Amendments is unlikely. However, she thinks that as the SEC progresses with further market structure reforms, it should be willing to consider eliminating rules that interfere with efficient methods of communication or market interactions, rather than imposing additional rules that merely mitigate the effects of prior regulatory choices.

“The fact that we have a rule in place that addresses a particular market structure issue should not be interpreted as prima facie evidence that the rule was a necessary or appropriate response to market failure when it was adopted, or that it remains necessary or appropriate given changes in the market,” she said.

She adds that the SEC needs to be open to considering whether the rule addressed a market failure at all, as opposed to a prior regulatory error.

She points to the SEC’s order protection rule as an example to this.

“This rule has exerted an outsize influence on the current shape of our equity markets, but the justification for the rule was never clear,” she said, adding that “it is clear that the rule distorts the markets in a number of ways.”

According to Peirce, the order protection rule pushes broker-dealers to prioritize price above all else in their execution decisions, regardless of the needs or preferences of their customers. She adds that it also “pushes all trading facilities toward increasing homogenization, and restricts exchanges, in particular, to distinguishing themselves from each other in ways that don’t necessarily enhance issuer and investor choice or serve their interests.”

“Given the lack of a compelling justification for the rule and its questionable effects on the market,” Peirce said, “I would suggest that we should start considering whether it’s worthwhile to continue focusing on regulatory tweaks to constrain market behavior that is driven primarily by the incentives created by the order protection rule.”

— Check out SEC Standard of Conduct Proposal Faces ‘Arduous Path’: Fi360’s Aikin on ThinkAdvisor.