September 19, 2009
Comment on Release 34-60604 File No. S7-21-09
Elimination of Flash Order Exception from Rule 602 of Regulation NMS
When I became a Professor Emeritus three years ago, I thought the Commission might finally have come within a very small step to achieve the national market system it was ordered by the Congress to facilitate in 1975. I did not anticipate for something to happen on which I would feel obliged to comment. But, as is so painfully apparent, the Commission has, in their almost tortured ways of writing hundreds of Releases, each of which tries to repair a defect created by the previous Releases, to arrive at this point. The Commission hasnt changed its ways
I have watched with more than a considerable amount of interest ever since that law was enacted—74 years ago—as the Commission fumbled and stumbled its way over the years trying to meet what had appeared to be a simple directive by the Congress. There is a sense of Dj Vu all over again, as the expert in using the best succinct words, Yogi Berra, said.
In plain English, heres what the Congress wanted the Commission to do: Facilitate the creation of a system, using the myriad of newly developed technical tools, that would enable a central market system (as it was then known generally), in which all bids and offers of qualified securities would be able to interact, thus making certain that all executions were guaranteed to have best execution (which always equals best price).
Until fairly recently that could have been accomplished by the Commission merely requiring that a rule mandating that best bid, first entered at a price would always be able to meet and interact with best offer, first entered at that same price.
First come, first served is a time-honored American method of providing service in a queue, whether at a tellers window or, in the army, at a chow line. Why not in a queue of orders?
If that had been the rule, flash orders would have been able to be executed without any further need to modify the trading system. If the flash order at the bid price had to meet and execute against the flash (or entered at any speed) order at the offer price, regardless of the speed used, the national market systems requirements would have been met.
Today there is one defect still exposed because the Commission didnt get it right in the 1970s. We now have a global market for most of our equities. The Commission has no authority to require foreign markets to operate as we dictate. However we still have one enormous advantage that we should use which should make these foreign markets work as do ours. Here it is:
Almost all global stocks are traded mostly in U.S. market systems. If the Commission ordered the price-time priority rule, foreign markets would be heavily motivated to enter their bids and offers into the U.S. system, thus placing them under the Commissions regulatory authority for that function.
That change would incent foreign markets to make certain their bids and offers always received best execution, and that would be because they traded in the United States national market system, thus creating what I have always predicted our markets should become: a global markets system.
Electronics and automated execution have been feasible ever since the Securities Acts Amendments of 1975. However, the Commission, fearful of offending the presumed experts in market design and operation (led by the New York Stock Exchange with its massive lobbying power) failed to modernize our markets, until finally the NYSE took the bull by the horns (to use the animal analogy favored by Wall Street), and merged with Arca, an event which probably saved the NYSE from immediate bankruptcy.
Approving the proposed rule about flash trading will once again increase the fragmentation of our market, a defect identified since 1975 (and even earlier) as one of the worst problems to be solved by the markets existing design.
Knowing how the Commission always relies on the perpetually-long list of Releases to make its rulings, may I refer you to the Releases surrounding the Commission-mandated National Market Advisory Boards existence from 1975-80, with particular attention to the proposal for what was then called by my two associates and me in April 1976 as The National Book System, otherwise referred to as The Peake-Mendelson-Williams System.
When Sextus Empiricus wrote the mills of the gods grind exceeding slow, he could not of course be referring to the Commission, but creation of a national market system seems in the running for second place in this instance.
Good luck with your seemingly endless task.
Junius W. Peake
Monfort Distinguished Professor Emeritus of Finance
University of Northern Colorado