On December 14, 2022, the U.S. Securities and Exchange Commission released four proposals to reform the stock market structure, generating a lot of buzz.
It was a big deal. The Wednesday afternoon announcement put an end to plans for compliance officers, technologists and market structure analysts hoping for a quiet holiday season as the industry immediately switched to analysis and response mode. In the weeks and months that followed, countless research reports were published, comment letters were written and in-person briefings were held to debate the good, the bad and everything else about the proposal’s impact on markets, liquidity and trading.
More than a year and a half later, one of the four proposals has been implemented, but the other three remain pending. While the industry has not lost interest in the pending items, the three proposals appear to have fallen off the top of the preparation and mobilization to-do list, and it is unclear how long the proposals’ lead architect, SEC Chairman Gary Gensler, will remain in his position.
The current status update is as follows:
Amendments to Rule 605
The SEC proposed to update the disclosures required by Rule 605 of Regulation NMS regarding order execution in National Market System stocks in the first substantive rule update since the rules were adopted in 2000. Of the four equity market structure proposals, this proposal received the most support from the industry, and on March 6, 2024, the SEC adopted the final rule changes.
Tick ​​Size / Access Fee
The SEC has proposed amending the minimum price increments, or “ticks,” for certain NMS shares. These proposals to amend Rules 610 and 612 have not yet been followed up on.
Brett Redfearn, founder of Panorama Financial Market Advisory and former director of trading markets at the SEC, believes this is the one of the three pending proposals most likely to resurface.
“The market structure rule we’re most excited about this year is the scaled-down version of Rules 610 and 612, the proposed changes to tick sizes and access fees, along with new round and fractional lots being delivered to the tape,” Redfern told Traders. “It’s reasonable to expect the commission to pass this in the fall, and that it will be significantly scaled back from the original proposal.”
The SEC is proposing new ticks of one-tenth of a cent, two-tenths of a cent and one-half of a cent. Redfern said the final rules will likely result in a penny restricted stock tick of only one-half cent, but that regulatory overreach in the definition of penny restricted stocks is likely to be controversial.
“This approval also includes a reduction in the access fee cap in Rule 610,” Redfern said. “The big question is whether the access fee cap will be 10 million or 15 million.”
Jesse Forster, senior analyst of market structure and technology at Coalition Greenwich, said the industry is open to trying to make the proposal work. “There’s a lot of interest in experiments and pilot programs around tick sizes and access fees,” he said. “The SEC’s notorious aversion to pilot programs is well-known, but if the SEC is willing to listen to the industry and design an appropriate pilot program, I think there’s a lot of support for it.”
Best Execution
The SEC has proposed a Regulatory Best Execution rule that would allow regulators to enact their own best execution rules in addition to those of the Financial Industry Regulatory Authority (Finra). The SEC proposal focuses on conflict-of-interest trading, where broker-dealers process retail orders while having potential conflicts of interest.
“The best execution rule has been very controversial since its inception,” Redfern said. “There has been a lot of opposition to some elements of the proposal, and it is unclear how the two versions of best execution, one for competing orders and one for non-competing orders, would work in practice.”
“Most importantly, I question whether the economic analysis underlying this rule will remain valid following the approval of Rules 605, 610 and 612, which completely change the standards,” Redfern added. “So I don’t think approval of Best Execution is a certainty.”
Order Competition
The SEC proposal that has been most heavily criticized by the industry is a proposed rule to increase competition for retail trading orders. The idea is that certain retail trading orders would be opened up to a newly created auction mechanism to increase competition and, at least in theory, result in better execution for retail investors.
“We’ve heard rumors that the auction proposal is stalled,” said Jim Angell, an associate professor at Georgetown University’s McDonough School of Business and an expert on market structure and regulation. “Maybe Gensler really took note of the storm of opposition to the plan. Even the exchanges that were supposed to benefit from it opposed it.”
“I think the prospects for race-to-order rules or retail auctions are all but gone,” said Coalition Greenwich’s Forster. “The institutional community has lost interest in even discussing how these would be run.”
“The competitive rules will likely be dead and never see the light of day,” Redfern said. “They were not a viable proposal, they were not well thought out, they were overly prescriptive and should never have been proposed as is. Without a substantially revised re-proposal, I don’t think the rules will ever gain traction.”
The Big Picture
The SEC is tasked with protecting “retail investors,” a point Gensler emphasized in explaining the rationale for his proposed stock market structure.
Market operators and retail trading platforms say the proposal goes too far and could backfire by reducing liquidity.
“It has never been easier or cheaper for retail investors to participate in the stock market,” Matt Billings, vice president and president of Robinhood Financial and Robinhood Securities, told Traders Magazine. “The SEC should approach any additional market structure reforms carefully, after carefully considering the impact of the recent Rule 605 reforms. The data on retail investors’ access to the stock market and the execution quality they receive when investing and trading does not support the aggressive reforms the SEC is currently considering.”
With the deadline for public proposals looming, Georgetown’s Angel noted the SEC has also been slow to move on smaller, more routine matters, such as NMS applications to update upper and lower limit (LULD) bands for exchange-traded funds (ETFs).
The scholar offered several theories that could explain the long lead time, including that Chairman Gensler may be prioritizing other rulemakings such as predictive data analytics, that the Chairman may be having difficulty getting the two SEC commissioners to majority-sign the final rule, or that the SEC has limited resources and is choosing to take its time to get it right rather than rush to pass something.
“Market participants across all sectors are eager to see some action from the commission on pending items,” Forster said. “The longer these actions drag on, the less likely they are to be implemented. With no industry support and in the lead up to the U.S. presidential election, the chairman’s time may be running out.”
“The lack of broad industry engagement was disturbing” before the SEC released its proposed stock market structure, Redfern said. “That created even more problems,” he said. “Chairman Gensler had a desire to get a lot done, which led to a proposal that wasn’t well vetted.”
“We have witnessed negotiated-style rulemaking where the proposed rules are intentionally overly broad in scope, allowing for amendments during the comment process, but remaining aggressive even after being restrained,” Redfern added. “In my view, the proposals generally reflect an overly cozy relationship with the major exchanges and a failure to appreciate or understand the benefits of hidden liquidity.”
What’s next?
The challenges ahead for the stock market structure proposal are further complicated by the timeline of the summer slow season over the next few months, followed by the pre-election season for two months, which could lead to regulatory actions being perceived as politically motivated. And the November presidential election itself could lead to Gensler leaving the commission before his term expires in 2026.
SEC Chairman Gary Gensler, in an interview at the Bloomberg Invest conference in New York on June 25, did not address the stock market structure proposal specifically but spoke generally about the SEC’s inbox.
“There are some rules that we’ve proposed that we haven’t adopted yet, and we’re working on them, but there’s no time limit on them,” Gensler said.
Gensler said he would be “honored” to serve as chairman until 2026, but that if a White House transition meant he had to step down, “that’s what democracy is all about.”
Gensler stressed that the SEC is not working on a timeline surrounding Election Day in November or Inauguration Day in January 2025. “We are considering public feedback on rules that we have proposed but not publicly adopted, but we are not time-bound,” Gensler said. “If you sprint down the field, you know where you will be when the umpire calls the clock.”
“I’d be willing to bet .500 odds on the Chairman’s proposal,” Redfern concluded. “Rule 605 will pass, and the reductions in minimum ticks and access fees are all but complete. But the order competition rule will be eliminated, and best execution may be in trouble.”
