April 21, 2010
This Concept Release's generality makes a response difficult to formulate, so I've procrastinated until the deadline.
1. Nobody wants to see a 1987 Crash happen in a tenth of a second. I support the SEC's efforts to make market operations transparent to all participants. Nevertheless, the tone of the Release gives me concern about potential regulatory overreaching that might do more harm than good.
1a. Arguably, legislative and regulatory overreaching after the 2000-2002 bear market have impaired the US stock market's competitive position relative to exchanges like Hong Kong and London.
1b. During the financial meltdown of 2008-2009, American stock markets functioned well. Presumably part of the reason is the technologies which the SEC is now scrutinizing.
2. I support the SEC's solicitude toward long-term investors. After all, monetizing future earnings is the market's economic function, and the long-term investor is more likely to utilize fundamental economic analysis than is the short-term speculator. Paradoxically, however, this reliance on fundamentals is likely to dispose the intelligent long-term investor toward inefficient markets because that is where bargains are to be found. The SEC should resist said investors' importunities to have inefficient markets created for them.
2a. Therefore, although long-term investor should be the SEC's highest priority, they should not be an unconditional priority. Long-term investors like large mutual funds can handle a degree of regulation which individual investors and small traders cannot. SEC regulation should not give large institutions a competitive advantage over small institutions, small traders, and individual investors.
2b. Large long-term investors presumably have the resources to develop countermeasures against the high-frequency strategies of their nimble competitors. They should adapt to new technology, not complain to the SEC about it. Nevertheless, the distinction between innovative trading and seizing unfair advantage may not always be easy to make.
2c. The reduced volatility, reduced spreads, and reduced transaction costs that technology has brought to the financial markets are to the advantage of small investors and traders who lack the resources and bargaining power of large institutions. The ongoing reduction in market friction is generally perceived as a good thing. It is a trend that the SEC should encourage albeit with a wary eye toward unintended consequences: although friction is undesirable in principle because it lowers efficiency, objects which friction constrains to slip slightly can slide catastrophically when friction is absent.
In summary, I fully endorse an SEC emphasis on market transparency. I urge to SEC to continue its support of the ongoing technology-facilitated reduction in market friction, but I agree that the SEC should monitor this trend for potentially severe unintended consequences. However, the SEC should not overreact to legitimate innovations, be they in technology or in trading strategies.