Stock Exchange Conflicts of Interests
Some products and services offered by the stock exchanges have been at the center of many market structure issues. Colocation, proprietary data feeds, special order types and rebates all seem to favor one class of investor over another and promote an un-level playing field. Since most U.S. exchanges (except for IEX and CHX) are public, for-profit companies, we would expect that they would do everything that they can to increase shareholder value. But is this profit motivation causing significant conflicts of interest? Earlier this week NYSE announced that they received a Wells Notice from the SEC which indicates that the SEC may bring an enforcement action against them. The notice dealt with NYSE’s handling of a July 2015 technical glitch which caused a 3 1/2 hour outage. Jeff Sprecher, the CEO of NYSE parent ICE, said :
“We dispute the appropriateness of the potential charges. At the end of the day it was a technology outage, it was very unfortunate, it was embarrassing and a black eye but we don’t believe that it actually violated any law.”
We can’t imagine that the SEC would bring an action because of a technical glitch since it’s impossible to have 100% bug free software. But maybe the SEC is concerned with how NYSE handled the situation. Did they treat all their customers fairly? Were all clients notified promptly of the problem? Did their largest volume clients receive any special advantages? These are the types of questions that we think the SEC might be thinking about.
Exchange conflicts of interests have long been a concern and the exchanges have actually felt the need to publish risk factors in their financials which detail these conflicts:
“The for-profit exchanges’ goal of maximizing stockholder value might contradict the exchanges’ self-regulatory responsibilities. The listing of our common stock on the NYSE could potentially create a conflict between the exchange’s regulatory responsibilities to vigorously oversee the listing and trading of securities, on the one hand, and our commercial and economic interest, on the other hand. While we have structural protections to minimize these potential conflicts, we cannot be sure that such measures will be successful.”
“We have self-regulatory obligations and also operate for-profit businesses, and these two roles may create conflicts of interest. We have obligations to regulate and monitor activities on our markets and ensure compliance with applicable law and the rules of our markets by market participants and listed companies. In the U.S., some have expressed concern about potential conflicts of interest of “for-profit” markets performing the regulatory functions of an SRO.”
“We have self‑regulatory obligations that may create conflicts of interests. We have obligations to regulate and monitor activities in our markets and ensure compliance with applicable law and the rules of our markets by market participants. In the United States, the SEC and others have expressed concern about potential conflicts of interest of “for‑profit” markets performing the regulatory functions of an SRO. For example, we are responsible for identifying possible violations of the securities laws by our members and taking regulatory action against those members if such violations are confirmed. Although our U.S. exchanges outsource certain of their regulatory functions to FINRA, we could be conflicted in pursuing such regulatory actions against our customers because to do so could result in a loss of trading volumes on our markets.”
Stock exchanges are no longer utility-like, member-owned companies that are primarily concerned about listings and trading. They are now multi-faceted, technology-oriented, global businesses that seek to increase shareholder wealth.
Have the exchanges gone too far? Have they forgotten their true role which is to assist in capital formation and allocation? In a WSJ interview this week, new Nasdaq CEO Adena Friedman said they were “more than an exchange company today”. While that might be great for their shareholders, we’re not sure if it’s so great for investors.