We like the above quote.  Consistency is something we have strived for over time; we have long believed it important for us to consistently question the status quo, and consistently pressure industry leaders and regulators for reform. We likewise appreciate when we see the leadership at our regulators display consistency in their zeal for what they do. This morning, we want to point out some of that consistency on display by Commissioner Kara Stein, as evidenced by her recent remarks to FINRA’s Division of Market Regulation. We’ll get to that in a moment… indulge us first in a little ground-laying.

There have been very serious and dangerous weaknesses in our market structure for a period going back many, many years. Despite the industry’s collective proclamations that our markets have performed admirably even in the midst of drastic economic crisis, we all knew that was not the case. For example during the 2008-2009 Financial Crisis, we all knew that a stressed market place (due to fundamental economic reasons) was made multiples more severely stressed due to microstructure issues. Those issues included computerized naked short selling, latency issues between the SIP and direct data feeds, fragmentation and unwanted intermediation, order flow leakage, and a market place rife with payment for order flow. We at Themis felt so strongly that these issues were ruining the markets that we even set about writing a book – Broken Markets – to chronicle our point of view.

Things have gotten decidedly better recently. The economic climate has improved greatly, so that the markets have become markedly less stressed (unless you look at anemic trading volumes – ask any broker or institutional trader about that stress). Our regulators have implemented several initiatives that have made the markets safer and fairer. Those initiatives include volatility guards, a ban on naked access, and a stepped up focus on enforcement. Exchanges have been fined. Dark pools have been fined. HFT firms have been fined.

Things are no doubt better today compared to how they were between 2007 and 2010, although recently we see that even in calm low-volume environments, the market structure is susceptible. So maybe the markets are not as “broken” as they were… maybe they just need further improvement and focus by our regulators, and further leadership within the industry to “do the right thing”. We can live with that, especially with the regulatory leadership currently on display at the SEC.

A few days ago we wrote in a note to you titled Tough Chicks, which highlighted  points made by Commissioner Kara Stein and Chair Mary Jo White in recent 2014 speeches. We pointed out common themes. While it is tough reading into commentary in an effort to set our expectations with regard to future regulator actions, sometimes the consistency of those comments can very well telegraph what is coming down the pike. This is especially true when the same points get touched upon in a series of speeches, by different commissioners, as they have been of late.

Ok… moving on to Commissioner Stein’s consistency… and let’s do that by first recapping a little from her February 2014 speech at Trader Forum…

February 2014 Commissioner Stein comments at Trader Forum:

On stale quotes, and SIP vs Direct feed speeds:

“Customers are ostensibly better off because they got a fraction of a penny in price improvement from the National Best Bid and Offer (“NBBO”) price.  But, is a fraction of a penny per share enough of a price improvement to be meaningful?  Does it matter if the price improvement is measured against a NBBO, which might be stale by the time the trade is executed?”

On broker routing and conflicts of interest in that routing:

“Do these [SORs] routers send orders to the venues that are most likely to get them filled?  Or do they send the orders to the venues that have the lowest cost for the broker, even if it might not get the order filled, or get the best price? When will an institutional broker commit capital to take the other side of an order?  Will an institutional investor’s order be seen by third parties, who may trade ahead of it, or otherwise take advantage of that information?  How should a trader measure execution quality?”

On Exchange SRO status:

“In a world where trading occurs in hundreds of places, which are for-profit enterprises, the exchange-based SRO model warrants significant reconsideration. Does it make sense for firms registered with the SEC as exchanges to bear the bulk of the costs to oversee a market that is much larger than their respective portions?”

On modernizing rules to make more types of “persons” accountable:

“Dealer registration and FINRA membership should significantly strengthen regulatory oversight over active proprietary trading firms and the strategies they use.”

Now let’s look at her commentary to FINRA’s Division of Market Regulation just two weeks ago:

May 2014 Commissioner Stein comments at FINRA:

On the stale quote – SIP issue:

“The SIP has long been plagued by underinvestment.  There are a lot of reasons for that, but the most basic one seems to be that the incentives are wrong.  If the SIP is slow and error-prone, then the proprietary feeds are relatively more valuable.  That is not the right incentive.

As a result, it’s likely only a matter of time until the SIP fails.  Although the industry is trying to fix the SIP, without fundamentally shifting the incentives, I fear we’re not likely to make much long-term headway. “

On Broker Routing and conflicts of interest in that routing:

“What are brokers doing?  Why are they doing it?  What are the problems you see for the entities themselves… What role can FINRA play in ensuring that investors are not harmed by brokers’ order routing practices?  What role can the Commission play? I think we need to empower market participants to better protect themselves.  Investors deserve to know what happens to their orders, and what that means for their executions. And we should make sure that investors have the tools, the training, and useful metrics to make informed decisions.  We should update best execution standards and improve best practices.  And we should revise reported metrics to make analysis more useful. The buy side needs to know what the sell side is doing, and why.”

On Exchange SRO status:

“They need to spend money to build systems that keep up with their business needs and regulatory obligations.  And, if an exchange fails to make investments in technology, then it should face the consequences for its failures.  SRO-based immunity does not protect against problems that arise from for-profit exchange activity.”

On modernizing rules to make more types of “persons” accountable:

“…requiring firms to take greater responsibility for their people.  The brokers who make trading decisions must be registered with Commission. But, what if the decision is being made by a computer?  Shouldn’t the computer programmer who’s writing the code be responsible for knowing the rules and not breaking them, the same as a human trader?”

 Commissioner Stein is consistent. Chair White is consistent. And because of that we think more change is coming down the pike. We would absolutely not be surprised to see a pilot on eliminating payment for order flow in a subset of stocks – on several levels. We also expect there will be increased pressure on latency differential improvements. Additionally, we believe there will be a much higher disclosure standard imposed on many levels, and throughout the industry.

Things frequently can and do change for the worse via an isolated catalyst. However things more often change for the better with consistent effort, focus, and message. We are pleased to see that now on display at the SEC.