Increasing Competition and Improving Transparency in U.S. Equity Markets

Today, the Commission is proposing substantial reforms to existing rules and adopting new rules aimed at improving transparency and increasing competition in the U.S. equities market.  By shedding more light on best execution of trades and fees, and increasing competition among trading venues, this package will lower transaction costs for retail investors. It will also expand the availability of decision-useful information to all market participants – especially working families who seek to build wealth by participating in our markets.

Before addressing the substance of these proposals, I would like to take a moment to highlight the tireless and extensive work by the Commission’s staff, and by the Division of Trading and Markets in particular, in crafting these proposals.

On an average day, U.S. equity markets trade over half a trillion dollars.  These markets are generally fair, efficient, and innovative.  For the most part, investors benefit from narrow spreads, low transaction costs and fast execution speeds.  The day-to-day work of the SEC’s public servants in overseeing these markets, in all of their complexity and variety, makes all of this possible and has served the public interest extraordinarily well for nearly a century.

Although the current market structure may work well for many market participants, it may not for others.  The meme stock event of early-2021 highlighted serious investor protection and market integrity issues.  Payment for order flow is one particular area of concern.  This practice all too often conflicts with a broker-dealer’s best execution obligation. 

As more retail investors participate in our markets, it is all the more imperative that we fulfill our responsibility to protect them by ensuring that our rules keep up with current market realities.  In the context of equity market structure, this means ensuring that the order routing and execution system is transparent, competitive, and governed by updated rules that protect investors.  A key question is whether certain conflicts and misaligned incentives place retail investors at a disadvantage relative to other market participants with substantial market power.  

To address some of these market distortions, and partially in response to an October 2021 SEC staff report, the Commission has already proposed rules to shorten the settlement cycle and to enhance short sale disclosures.  The Commission also previously issued a request for comment on the potential risks and benefits for investors of digital engagement practices.

To me, today’s proposals will protect the interests of working families investing to meet their financial goals, whether to raise capital for a small business, or to save for retirement or for a child’s education.  The proposals advance those interests by improving market quality and price discovery, promoting competition for retail orders, and enhancing best execution data.  These reforms offer direct and indirect benefits to retail investors.

Our equity markets are complex and interconnected and no set of reforms to market structure will ever be perfect.  That said, today’s reforms represent a thoughtful approach informed by empirical evidence and robust economic analysis. 

Rule 605

In the first element of this package of reforms, the Commission is proposing to update its order execution reporting obligations under Rule 605.  This rule has been in place since 2000 and has been essential in making publicly available monthly reports on order executions, including statistical measures of execution quality.  But updates to it are long overdue. First, the Commission is proposing to expand the scope of this rule to require reporting by retail broker-dealers with over 100,000 retail customers.  Second, the Commission is expanding the types of orders included as “covered orders” and the information required to be reported under the rule.  Finally, the Commission is proposing a new type of summary report designed to enhance accessibility to these 605 reports.

The proposed amendments to Rule 605 are well-tailored, require reporting by large broker-dealers and reflect that trading patterns have changed in recent years.

The reforms to this rule, coupled with the other market structure reforms the Commission is voting on today, go to the heart of the SEC’s mission of promoting fair and transparent markets and I am pleased to support them.  

Tick Size, Access Fees, Round Lots, and Odd Lots

In this portion of today’s open meeting, the Commission is proposing important amendments to existing rules that enhance market quality.  It is also proposing amendments to increase transparency of fees and rebates at the time of trade.  Taken together, these proposals will strengthen market competitiveness for all participants, including retail investors.

The current tick size and access fees were both adopted as part of Regulation National Market System in 2005, known as Regulation NMS.  Updates to both rules to reflect the current trading environment are long overdue.

The Commission is proposing to replace the current one-size-fits-all minimum increment with a variable approach that would change based on a stock’s recent average spread.  This would address inefficiencies in tick-constrained stocks, prevent other stocks from becoming tick-constrained and reduce costs, while preserving displayed liquidity. 

In addition, the proposal would even the playing field between on and off-exchange trading by applying the new variable ticks to both quoting and trading of NMS stocks.  The proposal will also reduce access fee caps, in part, to reflect the reduced minimum tick sizes.

Finally, the proposal would accelerate two definitions from the Market Data Infrastructure rules on round-lots and odd-lots. 

I am pleased to support this proposal.

Increasing Competition for Retail Order Flow

The Commission is proposing a new rule designed to promote competition in retail order flow.  Under the current market structure, certain common industry practices favor large, sophisticated market participants at the expense of retail investors. 

In order to begin addressing these issues, such as conflicted transactions involving payment for order flow, the Commission is proposing a new auction rule to promote a more competitive, transparent and efficient market structure.  The proposal requires marketable retail orders to be routed to competitive auctions at exchanges or alternative trading systems. This new rule is designed to benefit retail investors by increasing opportunities for their orders to receive better prices.  Other market participants also benefit by interacting with this retail order flow, which is currently inaccessible to them. 

I support the Commission’s goal of increasing competition for retail order flow and I share the concerns Commissioner Crenshaw highlighted about excess concentration in the wholesaling business.  Two firms accounted for two-thirds of executed share volume of wholesalers in the first quarter of this year.  This rulemaking is a novel approach in our equity markets and I also appreciate the evidence-based explanation earlier in the discussion about the cream-skimming and adverse selection issues that arise when certain market participants can exercise their market power.  And while the potential impact of this important proposal on overall market quality may be difficult to assess, on balance, I believe the potential benefits are worth exploring and welcome the public’s input on these potential benefits.

Strengthening Best Execution Standards

As part of the broader focus on equity market structure, this proposal would be the first time the Commission developed its own comprehensive and detailed best execution rule.  The proposal requires broker-dealers to adopt detailed policies and procedures, robust practices, regular reviews, recordkeeping, and heightened processes for handling conflicts of interest.  This approach will improve consistency in best execution practices across asset classes and encourage better execution for customer orders.  It will also facilitate enhanced regulatory oversight and enforcement by the Commission.

The proposal includes specific requirements for broker-dealers to address compliance with the best execution standard for transactions involving conflicts of interest, such as payment for order flow. It would also require broker-dealers to document how they complied with best execution in those circumstances and the basis for that determination.

The proposal applies to a broad set of assets, including equities, options, fixed income securities and municipal securities.  Given the different characteristics of these assets and the markets where they trade, the proposal provides broker-dealers with flexibility in complying with their best execution obligations.  Broker-dealers are expected to exercise their expertise and judgment when deciding where to route customer orders.  Their policies and procedures should be tailored to the specific and current risks of a firm’s operations and its regulatory obligations. 

I support this best execution proposal and look forward to reviewing comments submitted by stakeholders and the public.