If you are sensing that market structure reform is on the horizon that tilts the purpose and functioning of our equity markets back towards the needs of investors (as opposed to traders), you are not alone. We have long felt that the markets have evolved to elevate the needs of very short-term traders above the needs of long term investors, and we have made our opinion known to all who would venture to listen, be they audience members at local public libraries, industry conferences, readers of our blog, morning notes, our book… and even policy makers in Washington DC. We have spoken with members of Congress and the Senate, their staffs, and even SEC Commissioners – including Kara Stein, Mary Schapiro and Mary Jo White.

Recently we have been very pleased to see that our concerns are being shared in Washington. In February Commissioner Kara Stein gave a remarkable market structure speech to an audience at Trader Forum, and yesterday Commissioner Mary Jo White also delivered a great speech to audience members at the Sandler O’Neill gave a Global Exchange and Brokerage Conference. We sent you the text of the speech yesterday afternoon.

Commissioners Stein and White are tough. Very tough. Just one month ago Stein issued a scathing dissent to the SEC’s very own decision to continue providing special benefits to RBS after its conviction for manipulating interest rates. They are not afraid to examine long standing practices and challenge them, industry business models be damned, and it is refreshing.

This morning we wish to highlight just a few tidbits from each of their speeches this year. Their comments show that they understand the problems in today’s market structure., and they are making an impact at the agency. And while reform tends to happen incrementally (and rarely instantly), with these public servants we believe the times are a-changing.

Commissioner Kara Stein’s speech from February 2014:

On Retail Customers:

“Retail 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?  Would retail investors actually be better off if their trades were routed to the public execution venues?”

On Institutional Trading:

“Institutional traders seeking to keep their trading costs low now have to scan dozens of execution venues in search of liquidity, and are increasingly at the mercy of broker-provided, smart order routers to slice, dice, and feed out their orders into the marketplace.  Do these 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?[12]  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 the outsized volume of trades today taking place in dark venues:

“A growing body of research on datasets, both here and abroad, suggests that some of these potential efficiency gains may be overstated, plateauing, or even reversing.”

On Maker Taker:

“Does the complexity unnecessarily increase traders’ reliance on brokerage firms or consultants? We should explore how the maker-taker pricing model impacts liquidity and execution quality.  Does the current rebate system incentivize or penalize investors?  I have heard from many investors, and even exchanges, who are worried about the incentives embedded in the current system, and if there are proposals to explore alternative approaches, we should consider them.”

On Order Types:

“We should try to understand the various order types. Why would one exchange need 80-plus order types?  What is the purpose for each?  How do these order types interact with others, and how do they impact market liquidity and functioning?  We should be willing to re-examine the roles of these order types in the market.”

On regulatory burdens on exchanges versus dark pools:

“I also want to take a moment to assess the role of the self-regulatory organizations.  In a world where trading occurred predominantly on one or two venues, it made sense for those venues to have primary regulatory oversight over trading.  But, 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?”

Chair White’s June 5^th, 2014 speech:

“We must evaluate all issues through the prism of the best interest of investors and the facilitation of capital formation for public companies. The secondary markets exist for investors and public companies, and their interests must be paramount.”

On the institutional trading experience:

“Some potential additional benefits for investors from improved technology may have been diverted by excessive intermediation, and broad market quality would perhaps be even better if different rules were in place. Key costs for institutional investors in small-cap stocks appear to have remained relatively high since the financial crisis, in contrast to the large declines in such costs for the broader market. We are assessing the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them.”

On HFT – especially during times of stress:

“ … an anti-disruptive trading rule. Such a rule will need to be carefully tailored to apply to active proprietary traders in short time periods when liquidity is most vulnerable and the risk of price disruption caused by aggressive short-term trading strategies is highest. Dealer registration and FINRA membership should significantly strengthen regulatory oversight over active proprietary trading firms and the strategies they use.”

Do low-latency tools… tend to advantage certain types of proprietary trading strategies that may detract from the interests of investors? Some of the research suggests this may be the case.”

A nod to The Flash Boys Issue:

“And a related fairness concern is the latency difference between the direct data feeds and the consolidated feeds.”

A nod to Hunsader at Nanex:

“Exchanges: They are not allowed to transmit data to direct customers any sooner than they transmit data to the SIP, and the technology used for transmitting data to the SIP must be on a par with what is used for transmitting data to direct feeds.  I am also asking the exchanges and FINRA to consider including a time stamp in the consolidated data feeds that indicates when a trading venue, for example, processed the display of an order or execution of a trade.”

I am asking the exchanges to develop proposed rule changes to disclose how — and for what purpose — they are using data feeds. For example, which data feeds are used to execute and route orders? And which feeds are used to comply with regulatory requirements, such as trade-through rules? 

On dark pool and SOR transparency, and the SEC looking into Wholesalers:

“Transparency has long been a hallmark of the U.S. securities markets, and I am concerned by the lack of it in these dark venues. Transparency is one of the primary tools used by investors to protect their own interests, yet investors know very little about many trading venues that handle their orders. FINRA began disseminating aggregate information on trading volume of ATSs. This is a useful first step, but ATSs represent less than half of dark venue volume. To remedy this gap, I fully support FINRA in considering an expansion of its trading volume disclosure regime to off-exchange market makers and other broker-dealers.

Expand the information about ATS operations submitted to us and to make the information available to the public. As you have seen in the recent media, some operators of dark venues began offering greater transparency to their operations this week, but a broader effort is needed.

Enhance order routing disclosures. Rule 606 of Regulation NMS currently requires some public disclosure of broker order routing practices, but it does not cover the large orders typically used by institutional investors. The rule proposal would address this gap by requiring disclosure of the customer-specific information that a broker is expected to provide to each institutional customer on request.”

On order types:

“I am asking the exchanges to conduct a comprehensive review of their order types and how they operate in practice. As part of this review, I expect that the exchanges will consider appropriate rule changes to help clarify the nature of their order types and how they interact with each other, and how they support fair, orderly, and efficient markets.”

Hopefully you recognize each point addressed in the above speeches from our discussions with you over recent years. We are indeed pleased, not only because we witness our concerns being turned into actionable items by the SEC, but because our concerns are being handled by two very tough public servants.

We like tough.