SEC Commissioner Stein Speaks on Equity Markets and Self-Regulation (with Lofchie Comment)
SEC Commissioner Kara M. Stein spoke at the Trader Forum 2014 Equity Trading Summit regarding the evolving capital markets and subsequent challenges.
Commissioner Stein stated that over the years, pleas for fairer competition and safer trading spaces for institutional and other investors led the SEC to adopt Regulation NMS. She explained that there are currently 16 registered securities exchanges and dozens of "dark pools," which may account for over a third of a day's trading volume. As exchanges evolved, traders and their strategies involving advancing technology evolved as well, reducing the time of a trade to milliseconds. Stein notes that this evolution led to challenges such as technology glitches and "mini flash crashes," which should be viewed as "pieces of a puzzle; symptoms of something larger." In order to safeguard capital markets, Stein encouraged market participants, regulators, and stakeholders to coordinate best practices and available data. She suggested that firms with direct access to the markets and execution venues should be required to have detailed procedures for testing systems to ensure that they don't cause market failures. Additionally, Stein stated that firewalls and trading limits should be clearly defined and coordinated across markets.Commissioner Stein went on to discuss making capital markets more efficient. She noted that one reason market efficiency is a difficult issue is because there is a lack of available comprehensive data, and stated that the Consolidated Audit Trail ("CAT") is intended to address this problem. She explained that "all market participants should be involved in helping develop the CAT," and that "it is not, nor should it be, the exclusive province of the Commission or SROs." Commissioner Stein stated that she firmly believes that the SEC should develop policy from the facts, by gathering as much data as possible, and if an alternative approach deserves consideration, it should be tested and evaluated.Additionally, Commissioner Stein discussed the role of self-regulatory organizations ("SROs"). According to Stein, "in a world where trading occurs in hundreds of places, which are for-profit enterprises, the exchange-based SRO model warrants significant reconsideration." She questioned whether it makes sense for firms to bear the bulk of the costs to oversee a market that is much larger than their respective portions, and who should be determining and enforcing listing standards. She stated that FINRA has come to run many critical market surveillance functions, such as monitoring for insider trading and looking for cross-market manipulations, and the SEC must attempt to "better understand and clarify" FINRA's role as a private regulator.
Lofchie Comment: Commissioner Stein's comments on examining the role of self-regulation come at an important time given FINRA's announcement that it had been outsourced with "self-regulatory" oversight of essentially 100% of the U.S. equities markets. See FINRA and BATS Sign Regulatory Service Agreement; FINRA to Conduct Surveillance for Nearly 100 Percent of U.S. Equities Trading (with Lofchie Comment) (February 6, 2014). Commissioner Stein rightly questions whether the concept of "self-regulation," in the sense of a group of private entities that adopt and enforce performance norms of a group, should survive in it current form.Commissioner Stein displays an open attitude towards reviewing the operation of the National Market System. Considering how complex the rules have become, her remarks are welcome. One could take issue with her choice of words in one respect. She described adoption of Regulation NMS as the "impetus" to the change in market structure – which she indicates was the reason for ending the domination of the NYSE and Nasdaq. It would be fairer to say that Regulation NMS (and even more significantly, the forced repeal of NYSE Rule 390 that essentially required NYSE member firms to exclusively trade on the NYSE) lessened the SEC's ability to impede changes in market structure. Had market forces, rather than regulations, determined the structure of the market, the domination of equities trading by NYSE floor traders would likely have ended much sooner.