The Senate Banking Committee’s Securities, Insurance and Investment Subcommittee, chaired by Sen. Jack Reed, D-R.I., held a hearing this week on the nature and practices of the many trading venues, including 13 official stock exchanges and about 40 alternative trading venues (ATSs) on which equities are traded under regulations administered by the Securities and Exchange Commission (SEC).
The four witnesses, members of an industry committee that has been studying this area, represent various constituencies and points of view, often disagreeing markedly as to the facts and conclusions to be drawn regarding highly controversial policy issues raised by such anomalies in the market as the Flash Crash of May 2010, the faulty Facebook initial public offering and a trading debacle at Knight Capital that almost brought down the firm, issues that are supposed to be considered by the SEC whenever it resumes its consideration of market structure issues, a project that was sidetracked by the Flash Crash.
In lengthy opening statements, Reed and Joe Mecane, executive vice president and head of U.S. equities at NYSE Euronext, recounted the development of multiple and alternative market platforms under SEC regulations. Reed concluded that anomalies that have occurred in recent years call for a re-examination of whether the complexity and fragmentation of markets suggest revisions and the updating of SEC rules.
In response, Mecane called for the SEC to resume a “holistic” review of the rules governing market-maker obligations, bid increments, order protection and the complexity and overlap between dealers and exchanges, including the obligations of each when providing like services. The objective of the rules is to promote transparency, fairness and long-term capital formation.
He led all of the panelists in placing great emphasis on the proposed Consolidated Audit Trail (CAT) as an important project that would enhance the ability of the SEC to conduct market surveillance, the necessary prelude to fulfilling its enforcement responsibilities. (The origin of this project dates back to 1980.)
Dan Mathisson, head of U.S. equity trading at Credit Suisse, supported the SEC agenda, but proposed that it be expanded to include a review of the responsibilities of the exchanges. He recommended that the status of the exchanges as self-regulatory organizations (SROs) be re-examined on the ground that when the exchanges re-organized as for-profit entities six years ago, there’s no reason they should have been allowed to retain this status. In fact, courts have held this confers a form of sovereign immunity on them that Mathisson contended operates on them as a disincentive to act with due care, especially since they have outsourced most of their regulatory duties to the Financial Industry Regulatory Authority.
Furthermore, Mathisson advocated a comprehensive review and revision of rules that allow the exchanges to monopolize the provision of market data and to treat this function as a profit center, worth $400 million annually, taking advantage of what amounts to “a government-mandated windfall.”
In his testimony and in response to later questions, Eric Noll, executive vice president of transaction services for NASDAQ OMX, directly contradicted Mathisson and strongly defended the exchanges’ SRO role, claiming that the responsibilities the exchanges accept add value compared with the business models of competitors, which are not permitted and do not undertake to exercise self-regulatory authority.
He also defended high-frequency trading (HFT) and so-called “dark pools,” in which information on orders is not displayed to the public, as innovations that narrow spreads and provides liquidity to the equities markets.
Robert Gasser, CEO of Investment Technology Group, which is the largest provider of Transaction Cost Analysis, testified that the data support Mathisson’s statement that HFT has been beneficial and that the markets are not “broken,” although he acknowledged that the public has become disenchanted with equities due to such events as the Flash Crash.
This was the second in a series of hearings that is expected to continue.
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