SEC Slaps Down NASDAQ’s Latest Proposal
We have often used our morning note to criticize the regulators for their lack of oversight of the stock exchanges. However, today we would like to commend the SEC for appropriately striking down a controversial NASDAQ proposal.
Back in May of this year, NASDAQ proposed to offer a suite of execution algorithms to their members. ”The Benchmark Order would allow NASDAQ members to enter a single order in a single security that seeks to match the performance of one of three selected benchmarks – VWAP, TWAP or POV over a pre-determined period of time. On August 14, 2012, due to numerous concerns, the SEC began the process of not approving this new NASDAQ proposal. On January 11, 2013, the SEC formally disapproved the Nasdaq proposal.
Last October, we outlined a note from SIFMA which raised considerable objections to NASDAQ’s proposal. Amongst other issues, SIFMA was concerned that NASDAQ would enjoy an unfair advantage against their own member firms and could invoke their SRO immunity status if an error occurred:
‘Nasdaq’s proposal could create regulatory disparities that would give Nasdaq an inappropriate advantage over broker-dealers providing the same services..SIFMA believes that an algorithmic trading function clearly is not “incidental” to an exchange’s core functions….Nasdaq’s characterization of the proposal leads to concern that it would use the doctrine of regulatory immunity to protect itself from any liability that arises out of the Benchmark Order functionality, through systems issues or otherwise…he commercial offerings of a national securities exchange should not enjoy an immunity from liability that is not available to broker-dealers providing identical services.”
At the time, Themis Trading agreed with SIFMA and publicly wrote:
“It is clear to us that the SEC should finalize its disapproval of the NASDAQ proposal. The “benchmark order” proposal is further evidence of the blurred lines that now exist between for-profit exchanges and broker/dealers. Somewhere along the way, after Reg NMS, exchanges got the idea that they were just another for profit organization which were competing for client business. Adding a suite of algos doesn’t seem to us to be a function of a stock exchange.”
In their disapproval notice, the SEC stated:
“After careful consideration, the Commission does not find that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange. In particular, the Commission does not find that the proposed rule change is consistent with: (i) Section 6(b)(5) of the Act, which requires, among other things, that the rules of a national securities exchange be designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, to protect investors and the public interest, and not to permit unfair discrimination between customers, issuers, brokers, or dealers; and (ii) Section 6(b)(8) of the Act, which requires that the rules of a national securities exchange not impose any burden on competition not necessary or appropriate in furtherance of the Act.”
There were only two comment letters to the SEC on the NASDAQ benchmark proposal. One was the SIFMA letter that we mentioned and the other was a comment letter written by Professor James Angel of Georgetown University on August 12, 2012. Professor Angel thought the SEC was wasting their time by analyzing this proposal:
“All Nasdaq is proposing is to offer some industry-standard order types, just like many other market participants..The staff time wasted on this useless proceeding should be used to get the JOBS Act rules done quickly and correctly…However, the egregious waste of resources in proceedings like this seriously damages the credibility of the Commission.”
Professor Angel didn’t stop with just a comment letter. He also wrote a personal email on August 27, 2012 to Mary Schapiro, then Chairman of the SEC. He once again stated his opinion that going after the NASDAQ benchmark proposal was a waste of SEC resources. He wrote:
“Dear Mary, I think that the Commission needs to pay more attention to what the Trading and Markets staff is doing with its delegated authority. The ways in which they continue to misallocate resources hurts the credibility of the agency. At a time when the SEC is not able to meet congressional deadlines for JOBS Act rules, the staff has chosen to again institute proceedings to disallow a totally unopposed SRO filing.”
We would have to disagree with the Professor. Reviewing and disapproving a proposal where an exchange explicitly crosses the line into the brokerage world is exactly what the SEC should be doing. If this proposal would have been approved, you can bet the other 12 exchanges would have quickly submitted their own benchmark algo plans. Rather than blurring the lines between exchanges and brokers even further, we think what is needed now is more of a separation of duties. Brokers need to get out of the exchange space (dark pools) and exchanges need to focus on exchange duties (listings, investor protection, corporate services, etc).