February 7, 2022
At the core of its mission, the SEC is tasked with maintaining fair and orderly markets that facilitate capital formation. In any consideration of conditions that may require a rule change it is helpful to return to the original mandate to determine whether the status quo does or does not fulfill that mandate, and if necessary, what can be done to return markets to a fair and orderly state.
Markets ideally function to identify a fair price for goods and services, in this case shares of a publicly traded company. They achieve this using the broadly accepted laws of supply and demand: as the profit-seeking behavior of sellers meets the saving-seeking behavior of buyers at a given price, a voluntary exchange takes place in which all parties have access to the same information and can make an informed decision that ultimately results in a mutual benefit. This is definitional required for a fair trade. Crucially if all parties in the trade do not have the same information, the exchange cannot be truly fair.
Recently, SEC Chair Gary Gensler stated that anywhere from 90-95% of retail trades are not being processed in markets, but in off-exchange dark pools where the number, price, and directionality of trades are available only to existing large institutional parties that have the capacity to operate off-exchange.
Retail investor necessarily cannot fairly compete in a market where they do not have access to the full suite of information that allows them to judge whether a trade is executed at a fair price. In the mind of this investor there appear to be two markets: one that is public and free where retail and institutions engage each other on a supposedly even playing field, and another that is private and manipulated where institutional investors can front-run retail trades using Payment for Order Flow and trade securities in an obfuscated environment designed specifically to control and limit what information gets out and who has access to that information.
While these dark markets exist in their current form, the lit exchanges in public markets will constantly fall victim to a fundamental imbalance in access to information, where individual retail investors have their trades and other digital activity recorded and sold to the very institutions that claim to provide these retail investors access to a free and fair market. What actually happens is retail investors do not engage in a voluntary, free, or fair exchange rather they are manipulated into making trades at a disadvantage by large market-maker institutions who stand to profit from reacting rapidly to small price fluctuations using their unique perspective on retail trades.
The SEC and other institutions tasked with regulating American markets have allowed too much abuse, with too little enforcement, for far too long, such that large financial institutions no longer take enforcement action seriously as a deterrent to illegal behavior rather the fines paid after the fact are often pittances compared to the scale of fraud committed by these institutions tasked with stewarding our financial economy. Their mismanagement has caused untold misery in recent history and closer scrutiny is necessary to ensure that everyday working Americans do not have their livelihoods stolen from them by front-running traders shirking their fiduciary obligation.
If the SEC cannot protect individual Americans to the extent they can fairly participate in capital markets, how equal and free are we really?