Speech by SEC Commissioner:
Remarks for Open Meeting on NMS Rule Proposal
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
February 24, 2004
Like my colleagues, I also appreciate the staff's work on this proposal. You have worked hard during the past few weeks to take my comments. I agree with the Chairman and my colleagues that it is time to get something on paper and to elicit comment from the public on specific proposals. Thus, I am happy to vote to publish this as a proposal.
But, I want to shine the light on some other aspects of this proposal that are more troubling. For some time, I have optimistically looked forward to our publication of a market structure proposal. I envisioned a reform that would benefit all U.S. investors by allowing our capital markets to remain the best in the world by supporting investors' choices and ultimately their brokers' ability to perform their best-execution obligations.
I agree with Commissioner Glassman that what this package of proposals lacks is a global regulatory reassessment of our capital markets. This proposal basically is an add-on to the 1975 amendments to the Securities Exchange Act of 1934, but the markets and technology have changed drastically during the last thirty years. I am not sure that we can have meaningful reform that will allow our markets to adapt and respond adequately to global competitors during the next thirty years unless we clearly outline and understand the markets as the Commission did with the Special Study of 1963. That study dissected the state of the markets. That is exactly what the Commission should do now. The staff is capable of such studies - in 1992 the investment management division published a great study of the mutual fund industry that lead to important changes in the regulation of mutual funds. Market Regulation published a similar study in 1994.
Are we capable of that now? Yes, but I do not see that in this package. I am concerned that the broad undefined terms such as "access" and "access fees" may not provide enough guidance to the public so that those who want to comment on the proposals will understand their full impact. I would have liked to see us come out with proposals that set objective standards, which would allow the markets to operate efficiently and would remove the Commission from acting as a referee. One of the proposed rules would allow "fast" markets to trade through "slow" markets. Already, there has been much public debate as to which market is "fast" or "slow." How will we make these determinations fairly and in an unbiased manner if we have set no objective standards and make these determinations on a case-by-case basis?
The philosophy that we should promote is the one that the SEC has found most successful over the years: Set disclosure standards; prosecute fraud; allow competition; prohibit monopoly. Then, let the markets sort out their own business practices.
Friedrich von Hayek in a brilliant 1968 essay called "Competition as a Discovery Procedure" said that any central authority or government agency cannot have all the relevant facts to make decisions, no matter how intelligent or public spirited the government employees are. The facts can only be discovered by competition. Hayek pointed out that at every stage of this competitive discovery, government and regulators will try to preserve the status quo under the banner of "stability," rather than allow change to occur. He noted that regulatory policy is "more likely to prevent than to facilitate those changes … that are required to adapt the system to new circumstances."1
In fact, I think that the SEC stated it well in the 1971 Commission Study on Institutional Investors:
"[W]e do not believe, however, that it is either feasible or desirable for the Commission or any other agency of the government to predetermine and require a particular structure, and still less to specify now particular procedures for the markets of the future. It is better to observe, and if necessary, to modify the structure which evolves through the ingenuity and response of the marketplace to the extent changes occur that appear inconsistent with the public interest."
I have heard it repeated in the media over the past couple of days that our proposal is a momentous reform in market structure. Unfortunately, the reality is that the proposal brought before us today merely updates the current status quo. Let me make an analogy to my high school days in 1975 - the same year as the latest legislative amendments to the 1934 Act - when the car that some of my friends and I rode around in was a 1975 American Motors Gremlin. It may not have been the greatest luxury car, but it served its purpose and that was part of its charm. Today, I feel that this proposal is at best a "tune up" and a new paint job on our old 1975 AMC Gremlin. Instead of envisioning a superior design for our capital markets by taking into account new technology and by addressing the real problems associated with market data revenue and the self-regulatory model that have manifested themselves over the past thirty years, the Commission is trying to regulate their outgrowths such as locked/crossed markets and market data revenue allocations. We are treating the symptoms rather than the underlying problems.
These rule proposals attempt to plug the Gremlin's oil leaks, and update the car's interior by installing a CD player. Although the Gremlin perhaps is great from a nostalgic perspective, I doubt that a car manufacturer today could or would reintroduce the Gremlin with the same design, same technology, even with these new interior features. I think this analogy shows that the Commission's mandate of providing investor protection requires us to fix the real problems that create market distortions, instead of adopting incremental changes that attempt to fix unintended consequences that arose from previous regulatory actions.
There has been tremendous media coverage on the trade-through proposal. This proposal is so sweeping that it makes me question the feasibility and enforceability of the proposal. I am also concerned that the new trade-through proposal converts the old, unenforced trade-through rule into a customer protection rule. Our previous experience with the trade-through rule over the past twenty-five years in the listed market has shown that it has not worked. Even more important is that Nasdaq grew over the same time period into a highly competitive and efficient marketplace without such restrictions. I am concerned that imposing the trade-through rule with the proposed Fast/Slow market and Opt-Out provisions on BOTH the Nasdaq and Listed markets will harm the efficiency and liquidity of our markets. We have no prior experience with an enforced intermarket price priority rule and, to my knowledge, no readily available data that will calm my fears. Attempting to interact with the best-advertised price may not always mean that an investor is getting the best execution possible. That is why, fundamentally, a broker's fiduciary obligation to obtain the best execution possible protects all investors.
I am concerned that we not inhibit the future development and growth of our capital markets and the ability of those markets to innovate and compete in the global arena under a micromanaging regulatory regime. I am concerned that the implementation of such an extensive and possibly expensive trade-through rule in Nasdaq (which does not have a trade-through rule) and the listed markets (where no one complies with the existing trade-through rule) may cause irreparable harm to the liquidity and efficiency of our markets. I truly hope that we will not adopt these rules without the appropriate statistical analysis and evidence necessary to evaluate the possible outcome.
The proposal's treatment of the question of market data is another cause for my concern. Had the market data release been a separate proposal, I would have voted not to propose it. The problem is that today's proposal does not look at the broader picture regarding market data. Again, it accepts the status quo as a given, without fundamental issues. For example, whose property is this market data: investors' or the market centers'?
Market data fees generate some $400 million a year. This money supposedly pays for regulation, but there is little accountability for it. Money is fungible, and we have seen controversies over large amounts being paid to executives of some of these markets. It is time for a re-examination of this situation, from the ground up.
I do not have to tell you that much has changed in the 30 years since 1975. In 1975, Altair introduced the first personal computer, the Altair MITS 8800. Bill Gates established Microsoft the same year. During this generation in human years - multiple generations in technology terms - the world has advanced in ways that we could not have contemplated even ten years ago when the Market Regulation division published its Market 2000 report. Today's release focuses on the supply side of the markets - the different market centers, their technological prowess, and the manner in which they interrelate. What it does not focus on is the demand side - the investor. The demands of investors have driven the changes in the marketplace since 1975: the growth of ECNs as alternatives to the floor, trades executed in nanoseconds across markets, and third-party linkages among the markets. Without fully understanding the impact on investors, we are proposing structural amendments the consequences of which are left to chance. Perhaps it is time for Congress, after a generation, to again become more active in re-examining the fundamental principles here.
This proposal provides the means by which all interested parties can openly communicate with the Commission and provide assistance in developing a solution that will encourage competition and drive innovation in our capital markets. Although I have expressed my concerns, I look forward to hearing the overall comments on the proposal. I would like to urge all interested parties and investors to share their views.