Flag Day and the Future of FinReg


Today is Flag Day – a day all Americans take pride in our colors, democracy, and the fairness of our government.

U.S. financial markets have traditionally been among the fairest and most efficient in the world, and have enjoyed a high level of public confidence. For one thing, our disclosure rules for public companies lead the world with regard to transparency. Additionally, investors have always taken the SEC at their word to be true to their mission statement and principles:

“The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation” “

The SEC is concerned primarily with promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud.”

In recent years our regulators have been caught behind the eight ball. Antiquated rule processes have been no match for the speed of innovation brought about through technology, as well as financial lobbying. We are in uncharted waters. Our markets are intensely fragmented, complex, and move literally at the speed of light. As an industry we are grappling with a myriad of issues and consequences that have arisen from a situation where regulators have not kept up with industry they regulate. Some of these issues are:

–          Can for-profit stock exchanges be expected to apply principles of fairness to all types of investors and traders?

–          Can for-profit dark pools be expected to apply principles of fairness to all types of investors and traders? Do they even have to?

–          Can for-profit regulatory bodies be relied upon to protect all market participants equally?

–          How can all market participants be represented evenly in an era of big money and lobbying?

–          Should there be separate regulatory bodies and rules for exchanges and broker-dealers?

–          What is the difference between a dark pool and an exchange, given that dark pools are not always so dark and exchanges are not always so lit?

–          What is the appropriate mix of execution venues to insure that our public market reflect actual price discovery?

–          Is Price – Time priority a fundamental building block for fair markets?

–          Is payment for order flow appropriate?

–          What will make markets safe in all sorts of seas?

–          Is fragmentation good? If not, how can it be reined in?

–          When principles conflict with each other what is the appropriate hierarchy? Does price discovery and formation trump minimizing trading cost frictions? When the interests of investors conflict with the interests of traders, whose interests take priority?

–          Which is more flexible and capable for regulating and policing capital markets – a rules-based approach or a principal-based approach?

These are very difficult questions and issues. They must be addressed at the highest level at our regulators, and a meaningful framework needs to be agreed upon before we lay foundation for the next hundred years for regulating our markets. If our capital markets are to continue to be the envy of the world, big thinkers at our regulatory bodies must address these questions first, and quickly.

Happy Flag Day!