By James Dolan, Chief Compliance Officer at Luminex Trading & Analytics LLC
At the beginning of each new Presidential administration, everyone with a keyboard seems to churn out insufferable, know-it-all essays on all the things the new administration needs to do to “get things right this time.” This is one of those essays!
Jay Clayton’s tenure as Chairman of the SEC has concluded and President Biden has nominated Gary Gensler to replace him; Mr. Gensler previously served as Chair of the CFTC between 2009 and 2014.
As a new slate of leaders is appointed to the various departments of the SEC once the new Chair is approved by the Senate, the new team will be charged with setting priorities for 2021 and beyond. None of them asked for my advice (yet!), but that doesn’t seem to stop anyone else, so here goes. (You may be pleased to learn that I’m not really making seven suggestions, despite the catchy title for this essay.)
As the head of compliance for the buy-side-only dark pool Luminex, I feel uniquely qualified to offer some advice as you begin your tenure. We know well the challenges facing institutional investors and off-exchange trading venues, and humbly present our suggestions to you here. (We’ll let the sell side and the exchanges reach out to you separately.)
- Continue to Keep an Eye on Retail Investors
Wow – you were nominated before all of this Reddit/GameStop/AMC stuff started happening! What in the world are you going to do with all of that? We at Luminex serve as a block trading utility for the buy side, but we believe the markets should be a welcoming place for investors of all sizes, types, and levels of expertise and sophistication. As such, we try to take a broad (and long) view of the markets. I was a regulator back in 1901 during the Northern Railroad short squeeze and I can tell you that it was a tough problem to solve then and it’s even harder now. I wasn’t intending to address this issue here, but I’ll leave it at this: your predecessor as Chairman devoted considerable attention to protecting “Main Street investors” and that should always be a point of focus for the SEC.
I’m all for democratizing investing so that everyone has a chance to participate in the markets but I’ve also seen what can happen when unsophisticated investors try to do battle with professional traders while stock manipulators count their money and laugh on the sidelines after they got out at the top. (See, “Wall Street, Wolf of”) Commission-free trading and the ability to buy fractional shares and odd lots have absolutely allowed more people to invest in our capital markets but it’s the equivalent of giving everyone matches so they can make their own fires to cook food and provide heat.
Some are going to do that, but other people are going to burn the forest down. The SEC should continue to look for ways to allow retail customers to participate in our capital markets while protecting them from unscrupulous manipulators and, in some cases, protecting them from themselves. Retail investors (as opposed to retail traders) are not to blame for scenarios like GME and AMC! But they are the first ones to get burned by trying to get in on whatever someone on some message board says is the next great way to “stick it to [someone] and make a killing in the market”.
- Appoint an Electronic Trading Czar
Much as Manisha Kimmel was appointed Special Policy Advisor to the SEC Chairman to help get the Consolidated Audit Trail (CAT) over the goal line, you should consider appointing someone to oversee and be directly responsible for the continued evolution and development of electronic trading across all product types.
The December appointment of Valerie Szczepanik as the Director of FinHub at the Commission certainly lays the groundwork for addressing some “fintech” issues like blockchain and roboadvisors, but we need to maintain a focus on electronic trading in equities and also the fixed income markets. The continued proliferation of exchanges with varying order types, and the dispersion of capital, make trading less efficient. As I suggested on these (virtual) pages last summer, a new “Market 2000” type of study should be done to assess the ongoing utility of Reg NMS, which has obviously had some terrific benefits but also many unintended consequences.
Having to consider the top-of-book at more than a dozen exchanges cannot possibly be the most efficient way to trade equities. I’d recommend that your new Electronic Trading Czar reinstitute the Equity Market Structure Advisory Committee to look at our markets in a holistic fashion with an eye toward improving them for the next generation of traders.
- Take Another Flyer at a Transaction Fee Pilot
Your agency should try again to implement a transaction fee pilot to assess how conflicts of interest from payment for order flow impact broker routing decisions. Whether it’s payments by market makers/liquidity providers to retail brokerages or exchange “rebates” to brokers that route them the most orders, I know that you know that this is an issue worth exploring.
The exchanges fought the SEC’s Transaction Fee Pilot proposal tooth and nail, which only goes to show how lucrative this whole construct is for them. You could issue a proposal tomorrow to mandate wider spreads in small cap stocks and you’d be getting love letters from Nasdaq and the NYSE. But take a peek under the hood of their rebate regime and they sic the dogs on you.
I guess hell hath no fury like an exchange scorned. There are ways to examine these issues that won’t get overturned by an exchange-friendly court. Find them. And I’m sure that our buy-side clients would appreciate the SEC’s view on whether brokers routing their orders to various venues are doing so to seek best execution or because it’s a better financial deal for the broker.
- Conduct a Wholesale Review of Required Disclosures
I hate tiny print on documents (and I’m a lawyer who has written my fair share!). As part of your efforts to protect investors (see Item 1 above), I would highly advise that you look at the value of the copious numbers of disclosures that protect the disclosing entities but do nothing for the consumers that are supposed to read them and don’t. Whether they are disclosures in prospectuses, 10Qs and 10Ks, brokerage firm account statements or on websites, there is a lot of disclosing and not very much informing going on in our markets.
What good are order routing or execution quality disclosures to the investing public if Mom and Pop don’t read them? As an ATS that trades NMS equities, we have to make extensive disclosures to the SEC and to the public on Form ATS-N (see below). There is no doubt that such disclosures are helpful to regulators, but I wonder whether our filings are read by anyone else besides our competitors, trying to see how our system works as compared to theirs, or maybe how we answered a particular question.
And (as we said in a 2016 ATS-N comment letter), we remain concerned that unduly burdensome filing requirements may dissuade some ATSs from continuing to operate and may discourage other innovators from trying to come to market. Continued innovation and competition are important facets of healthy markets and we support efforts to foster these qualities in U.S. markets.
- Continue to Focus on Streamlining SEC Filing Processes
As I’ve said in this space before, EDGAR has been a terrific one-stop shop for investors and other market participants to quickly get information on issuers and market professionals. And that’s great! But EDGAR can be a complete bear to use: filing the initial Luminex Form ATS-N via EDGAR was among the more frustrating experiences of my professional life and I wouldn’t wish that on anyone. That being said, at least it is an electronic submission method, which makes a ton more sense than the old method of mailing hard copies or sending them via courier.
As the pandemic was starting, the SEC granted relief to firms that had been required by rule to submit hard copy filings to the Commission for Forms ATS-R and ATS and the like. The rule proposal on roping government securities ATSs into EDGAR-land includes provisions to formalize and make permanent the electronic submission of ATS-Rs and certain ATS filings via EDGAR. I think that’s a good thing for investors, and if the SEC can continue to make EDGAR work better (please enable cutting and pasting!), then it will become even more efficient. And everyone benefits from that.
Gee whiz, Jim – are you done?
I am. Five habits of highly effective regulators and not seven – you’re welcome!
Kidding aside, my best wishes to the new SEC Chair as he embarks on his journey to lead the agency. I’m sure you’ll get a lot of unsolicited advice (like this!), but you’ll also find a lot of people who share your goals of protecting investors and ensuring that U.S. markets remain the most efficient and best regulated markets in the world. Holler if you need our help and we’ll come running.