Remarks at the SIFMA Equity Market Structure Conference: The Dynamics of our Markets and the Changing Structure on which they are Built
New York, NY
Sept. 19, 2019
Thank you for the kind introduction, T.R. [Lazo], and good morning to you all. I am grateful to be here today to discuss our equity markets. Before I begin, I must deliver my usual disclaimer that my views and remarks are my own and do not represent those of the SEC or my fellow Commissioners. If my wife were here, she would add her name to that list.
It is an exciting time to be at the Commission. Many of you know this, but for those who do not, I joined the SEC as a Commissioner one year ago, in September 2018. Several years earlier, I was Counsel to then-SEC Commissioner Daniel Gallagher. I also spent time earlier in my career working at a public company that owned several exchanges, at a law firm, and most recently at the Senate Banking Committee.
Market structure—especially that of our equity markets—has always been a topic of great interest to me and one about which I care deeply. Each year, I look forward to the fall, not only because it brings great weather, but also because it kicks off what I like to think of as “Equity Market Structure Season.” This is a time (usually beginning with this conference) when stakeholders from all corners of our markets gather and discuss ways to make them better.
This year, the season is particularly exciting. Many of the issues that have been raised repeatedly since the adoption of Regulation NMS—and discussed and scoped over many years—are now very much on the SEC’s radar. For this, I credit Chairman Jay Clayton and Brett Redfearn, the Director of the SEC Division of Trading and Markets, who will speak with you later today. Together, they have moved equity market structure to the top of the Commission’s agenda. I encourage you to read the Chairman’s and Director Redfearn’s March 2019 speech, which addressed several issues we grappled with over the past year and discussed potential steps for the future.
To put things into perspective, the SEC proposed Regulation NMS more than 15 years ago.  Much of the debate and consideration that went into that proposal, and ultimately its adoption, had been going on for several years before that. We also are nearly 10 years removed from the SEC’s equity market structure concept release. Not only does this remind us all of how old we have become, but also that discussions like these likely will continue for several years after our time in this space ends and others fill these roles and seats. Nevertheless, my hope is we can tackle several of these issues in the near term and finally put them to rest (at least for some time).
Today, I am honored to begin Equity Market Structure Season with a few remarks on existing regulation. I will start by focusing particularly on broker-dealers’ best execution obligations and the “Order Protection Rule” (“OPR”). Then, I will offer a few ideas on other areas of the securities markets that are of interest to me. Along the way, I will pose some questions that could help regulators better consider these areas.
Structure vs. Dynamics
When I hear the term “market structure,” I think stability and reliability. In my view, our markets have structure now and have for quite some time. Our markets work incredibly well and mostly as intended. Because of this, our equity markets are the envy of the world. This stability and reliability are key factors that drive so many companies to raise capital in the U.S. and cause investors to feel more comfortable investing in the market. But maintaining stability and reliability requires vigilant attention. Our markets are constantly evolving and, like many things in life, just when we think we have it all figured out, some unforeseen or unlikely development brings us back to the drawing board. Unintended consequences can result from new or modified regulation—I will elaborate on this in a moment.
As a regulator, it is incumbent upon me and my fellow Commissioners to ready our agency and prepare our markets so that we can respond to the unforeseen and foster resiliency. As one of the Commissioners of the SEC, I must also promote the agency’s tripartite mission of investor protection, maintaining fair, orderly, and efficient markets, and facilitating capital formation. Our equity markets play a pivotal role in achieving all three components of this mission.
We must strive to ensure that our markets and our regulations keep pace with innovation and change. We rely on the tremendous staff of the SEC’s divisions and offices to help us do this. You, your colleagues, and the organizations you represent also play pivotal roles. Your insight and stewardship are vital to ensuring that our markets not only keep pace with changes in market trends and technology, but that they are resilient no matter the conditions.
It’s All Connected
It is fitting that Equity Market Structure Season begins in the autumn, when we all pull sweaters out of our closets. I often think of the laws and regulations that govern our industry like the woven threads in a sweater. Pulling to tighten one typically loosens another elsewhere. Sometimes those effects are intended. At other times, however, they are not. And, the unintended effects may even be more significant than those we had aimed to produce in the first place. I am mindful of this interconnectedness, and it factors into my decision-making when I consider new or amended rules and guidance for our markets and their participants. I will elaborate on this by sharing a few thoughts on best execution, OPR, and other evolving areas of our markets.
It is a longstanding principle that a broker-dealer has a legal duty to seek to seek to obtain best execution of customer orders. The SEC takes broker best execution obligations very seriously, and our Division of Trading and Markets previously has stated that the “obligation constitutes one of the cornerstones of market integrity.”
In my conversations with firms during my first year as a Commissioner, it became clear to me that the duty of best execution is one that brokers and the rest of the industry also take seriously. It is pervasive in the routing decisions they make every nanosecond of the trading day. I have heard several firms point to best execution as a primary driver of why they take certain actions or, conversely, as the basis for why they are unable to pursue otherwise seemingly practical alternatives to the existing way of doing things. Take, for example, exchange proprietary data feeds and the feeds from the securities information processors (“SIPs”). I often hear, both from brokers and asset managers, that they would not consider best execution satisfied if the SIPs are used for pricing in broker routing algorithms. Some say this is because of the lag in the SIPs versus proprietary feeds. Others point to the richer content in proprietary feeds compared to “Core Data” in the SIPs.
I think we can all agree that best execution is incredibly important. But what exactly is best execution? I ask this rhetorical question knowing full well that the duty is intended to be principles-based on an order-by-order basis. Nevertheless, I think the Commission should consider setting forth a non-prescriptive interpretation of, or guidance on, the regulatory requirement to achieve “best execution.” I emphasize regulatory requirement because I believe, in general, there should be a difference between what regulation requires and what businesses do for commercial reasons. Regulation sets a baseline that should apply across a variety of market niches and throughout different market conditions. Commercial demand, on the other hand, varies across different customer types and cycles of the economy. I believe regulation should set a baseline and allow for firms to go further than what is required to satisfy best execution, when they choose to do so for commercial purposes.
The premise of best execution is to seek the most favorable terms for a customer's transaction under the circumstances. In many circumstances, price and speed ultimately may be determinative inputs after a broker analyzes its regulatory best execution requirements. Rule 605 under Regulation NMS specifically mentions execution price and speed. But the SEC has previously cited many other aspects of a broker’s routing decision that are factors in obtaining best execution of customer orders. These include size, availability of information, trading characteristics of the security, transaction costs, and ease of getting a fill. Going beyond the SEC, FINRA cites several other factors surrounding best execution, including price improvement opportunities, differences in price disimprovement, the likelihood of execution of limit orders, customer needs and expectations, and the existence of internalization or payment for order flow arrangements.
And yet my concern is that, for some, the focus on price and time and the avoidance of trade-throughs has become a substitute for a more robust best execution analysis—the notion being, that if brokers simply seek the best price at a given moment, other variables are less important, or perhaps more difficult for a regulator or customer to criticize. I recognize that some of this may result from a weighing of risk, both from a regulatory standpoint and also commercially. Whereas several best execution factors are subjective in nature, and perhaps defensible under scrutiny, price is relatively cut and dry. But price is just one factor in a best execution analysis, not only when firms make routing decisions, but also when regulators review these decisions after the fact. Finally, some have noted that this framework for regulator review of best execution often has been process-oriented—i.e., requiring that brokers show their work—rather than focused on outcomes for customers. Is this how we should continue to think about best execution, or should we focus more on outcomes? For example, what if a broker accesses a quote with relatively small size, perhaps to satisfy OPR, but by doing so chases off a larger order that may have more closely achieved best execution for the customer? Should there be some combination of approaches, such as a safe harbor for certain outcomes?
I think investors, our markets, and the industry as a whole would benefit from this Commission saying more on broker best execution, especially if the current lack of guidance may hinder the ability of firms to satisfy best execution in a flexible, practical, and principles-based manner. Past Commissions generally have refrained from defining best execution. For example, the Commission that adopted legacy Rule 11ac1-5, the predecessor to Rule 605, noted that it was “not defin[ing], either explicitly or implicitly, a broker-dealer’s duty of best execution.”  There also were several requests for clarification of a broker-dealer’s duty of best execution when the SEC proposed Regulation NMS. Ultimately, however, that Commission chose not to provide further guidance on best execution, but instead explained the history and background on the obligation.
Given where we are today, with so much focus on price and investment into achieving high speeds, I believe further guidance is needed. I am particularly interested in your views on best execution and OPR in tandem. For example, has OPR inhibited certain trading behavior that may have otherwise achieved best execution? Perhaps worse, has OPR required other behavior that may have even impeded best execution? These are additional examples of that push and pull—cause and effect—inherent in our regulatory process. I encourage you to share your thoughts on best execution, as a regulatory requirement and as you pursue it from a commercial standpoint in your businesses.
Order Protection Rule
As for OPR, I would like the Commission to take a closer look at the rule and its effect on our markets, and to consider whether minor adjustments or more significant changes are appropriate. The SEC’s Strategic Plan notes the importance for the SEC to “continually analyze and seek feedback from investors and others about where rules are, or are not, functioning as intended.”  I think this review should include the OPR.
When the SEC approved Regulation NMS in 2005, it could not have envisioned that 14 years later there would be 13 active equity exchanges, with a 14th recently approved, and two more rumored in the works, as well as more than 30 alternative trading systems. Despite the growth in numbers, of those 13 exchanges, the two largest by volume generally account for approximately 30% of average daily trading volume (“ADV”) industry-wide. Drilling down further, three exchange groups control 12 of the 13 active markets and account for nearly 60% of ADV. However, excluding the dominant exchange from each of those three operators (or the two most dominant in the case of Cboe), each remaining exchange accounts for significantly lower percentages of ADV.
On the one hand, I think it is wonderful and important that our regulations may have encouraged competition, evolution, and innovation in the exchange space. However, the equity markets also have undergone significant consolidation in recent years—with certain exchange operators acquiring other markets that previously operated independently. The statistics I just mentioned show that a handful of dominant exchanges continue to attract the majority of on-exchange trading volume (albeit less so than before Regulation NMS when it was just two dominant players). But with OPR, brokers are inherently forced to connect to, purchase market data from, and take into account prices on all exchanges. This is the case whether or not each particular exchange is independent or if it is one of three, four, or even five controlled by the same operator. This also is irrespective of the volume on that market or the relative size at the National Best Bid or Offer.
All of this leads me back to OPR. Is OPR, as it exists today and in this environment, best for investors? For brokers? For exchanges themselves? When the Commission adopted OPR, it noted that OPR was established to protect against trade-throughs for all NMS stocks and to protect only quotations that are immediately accessible through automatic execution. Considering the original rationale for OPR and the mostly electronic nature of our markets today, is OPR still needed? If the SEC were to set forth clearer expectations on best execution, how would that affect the use case for OPR? If we think OPR still serves an important purpose, should we think about any adjustments? Perhaps we should increase the number of round lots needed to qualify as a protected quotation? Or conversely, for expensive stocks, maybe we should consider reducing the number of shares needed to qualify as a round lot? What if we created an exemption for block-size orders? Should OPR apply only to exchanges that reach a specific, minimum ADV over a set period of time? On this last point, if we were to go down that path, should we consider some regulatory action to encourage new entrants and to protect the smaller markets that exist today and the roles they serve?
These are just a few ideas to spur conversation—I am not committed to any of them. But, I do feel strongly that, since we have lived with OPR for nearly 15 years, we should use the data and experience we have accumulated to reexamine it.
I have named two areas of existing equity market structure regulation that I believe we need to reassess generally. Now, I will mention two more that interest me, and pose a few questions for your consideration.
First, I would like to talk about order management systems (“OMSs”), which many buy side firms use for various functions, including to connect with trading counterparties and to manage the lifecycle of their orders. OMSs are used extensively in our equity markets, including for the deployment of brokers’ routing algorithms. Clearly, they are performing services that market participants value, and they have become interwoven into the equities environment. I would like to better understand this thread running through the equities markets. What services are OMSs performing that used to be performed by other players that we directly regulate, such as broker-dealers, exchanges, ATSs, etc.? If these services are getting consolidated, does that raise new risks to investors or our markets that our existing regulations were intended to address? Since broker-dealers and advisers are still on the hook for all of their compliance obligations, how are they diligencing and overseeing these OMS providers when they perform such services? Also, I have heard concerns regarding the opacity and pricing of OMS vendors. Notably, given asset managers’ own best execution obligations, how are advisers thinking about the fees they and their brokers pay to OMS providers? At a threshold level, are OMS fees adequately transparent for their consideration?
Now, I will wind up my remarks by moving beyond our public equities markets to discuss what has been known to be a regulatory gray area for some time. I believe we need to consider the role of “finders”– those who help small businesses, seeking to raise capital, identify and locate potential investors (typically for a fee). Finders can play an important role in filling the gap to help small businesses obtain early stage financing. But, the regulatory framework that governs them has been ambiguous at best. On the one hand, the role of these companies or individuals is akin to that of a broker, including that they receive transaction-based compensation, but they are not subject to the same requirements as broker-dealers. On the flip side, they frequently do not handle securities or funds, rendering the purpose of some broker-dealer requirements inapplicable. I believe it is time for the SEC to put some clear rules in place, not just staff no-action letters and enforcement actions, so that we can clarify for our markets and investors the benefits and obligations of finders. Such clarity would also allow finders to operate with greater certainty and would give issuers peace of mind that their offerings are not being facilitated by unregistered brokers. I welcome your thoughts on this topic, especially those who are existing brokers and have experience being subject to our current broker-dealer regime.
I hope you will consider the issues I have spoken about today and provide feedback. And, as you go through Equity Market Structure Season, I ask that you keep my sweater analogy in mind: changes we make in one area of the market inevitably affect some other part of it.
Thank you again for spending your time listening to a few of my thoughts. I will close by reiterating what many of you have heard me say before—stop in and visit when you are in D.C. Tell us what you are seeing and where you think we may be able to improve our markets. You are working on the front lines and grappling with the markets and their idiosyncrasies on a daily basis. We truly learn so much from these interactions. They help inform my views on where things are working well, where our markets may have regulatory gaps, where minor adjustments could make a difference, and where significant change may be needed.
I wish you a great conference, and thank you again.
 Jay Clayton and Brett Redfearn, Equity Market Structure 2019: Looking Back & Moving Forward (Mar. 8, 2019), available at https://www.sec.gov/news/speech/clayton-redfearn-equity-market-structure-2019.
 The Commission adopted Regulation NMS in 2005. See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29, 2005) (“Regulation NMS Adopting Release”). The Commission originally proposed Regulation NMS in February 2004. See Securities Exchange Act Release No. 49325 (Feb. 26, 2004), 69 FR 11126 (Mar. 9, 2004) (“Regulation NMS Proposing Release”). The Commission issued a supplemental request for comment in May 2004. See Securities Exchange Act Release No. 49749 (May 20, 2004), 69 FR 30142 (May 26, 2004). In December 2004, the Commission reproposed Regulation NMS in its entirety for public comment. See Securities Exchange Act Release No. 50870 (Dec. 16, 2004), 69 FR 77424 (Dec. 27, 2004).
 See Securities Exchange Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010).
 Rule 611 under the Securities Exchange Act of 1934 (“Exchange Act”).
 See, e.g., Regulation NMS Adopting Release at 37537, note 338. See also Securities Exchange Act Release No. 37619A (Sept. 6, 1996), 61 FR 48290 (Sept. 12, 1996).
 See Division of Market Regulation, Market 2000: An Examination of Current Equity Market Developments, available at https://www.sec.gov/divisions/marketreg/market2000.pdf.
 Exchange Act Rule 605. This rule generally requires a market center that trades NMS stocks to make available to the public monthly electronic execution reports that include uniform statistical measures of execution quality. See, e.g., Rule 605 “FAQs”, available at https://www.sec.gov/divisions/marketreg/nmsfaq605.htm.
 See, e.g., Securities Exchange Act Release No. 43590 (Nov. 17, 2000), 65 FR 75414, 75418 (Dec. 1, 2000).
 See, e.g., FINRA Rule 5310.
 See supra note 8.
 See, e.g., Regulation NMS Adopting Release at 37537, note 336.
 See Regulation NMS Adopting Release at 37538. “At the same time, however, the Commission recognizes the validity of concerns expressed by commenters with respect to the need for guidance concerning their best execution responsibilities after implementation of Regulation NMS.” See also Regulation NMS Adopting Release at 37538, note 340.
 See U.S. Securities and Exchange Commission, Strategic Plan, Fiscal Years 2018-2022 (Oct. 11, 2018), available at https://www.sec.gov/files/SEC_Strategic_Plan_FY18-FY22_FINAL_0.pdf.
 See Securities Exchange Act Release No. 85828 (May 10, 2019), 84 FR 21841 (May 15, 2019).
 See, e.g., https://www.prnewswire.com/news-releases/group-of-leading-retail-brokers-financial-services-firms-banks-and-global-market-makers-plan-to-launch-the-only-member-owned-equities-exchange-memx-members-exchange-300773713.html; https://www.marketsmedia.com/miax-parent-to-launch-equities-exchange/.
 See, e.g., https://markets.cboe.com/us/equities/market_statistics/.
 See, e.g., Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248 (June 5, 2019), 84 FR 33669 (July 12, 2019).