SEC Commissioners Question Value of Trade-Through Rule
Commentary by Steven Lofchie
SEC Division of Trading and Markets Director Jamie Selway reported that the agency is examining potential modifications to Rule 611 of Regulation NMS ("Order Protection Rule") and related market structure requirements. The Republican Commissioners all expressed skepticism about the continued justification for the rule.
At a roundtable on the regulation, the SEC reviewed (i) Rule 610 requirements relating to fair access, access fees, and locked or crossed markets; (ii) Reg NM-defined terms and their effects on the national best bid and offer ("NBBO"), and incentives associated with the market data revenue allocation formula; and (iii) enhanced best execution guidance if the Commission modifies or rescinds Rule 611's trade-through prohibitions. Mr. Selway said the goal was to examine the rule's "entanglements with other requirements" to ensure any changes improve rather than damage market structure. He said that maintaining a "robust, transparent, reliable NBBO is essential for fair [and] efficient ... markets."
The Republican Commissioners weighed in:
SEC Chair Atkins said that Regulation NMS Rule 611's trade-through prohibitions have contributed to market fragmentation, dispersed liquidity, and "diminished transparency." He called for a comprehensive reassessment of the rule and related provisions. At the roundtable, Mr. Atkins said that two decades of experience have vindicated concerns he raised as a Commissioner in 2005 that Rule 611's rigidity would hinder long-term market growth. According to Mr. Atkins, the rule has "invited gamesmanship" and "produced unintended consequences" that now require correction.
SEC Commissioner Peirce questioned whether the trade-through rule may now cause more harm than good, noting that off-exchange trading volumes are rising while new exchanges "continue to proliferate." Ms. Peirce also stated that dictating how market participants execute trades has never seemed like an exercise for which the SEC is well-suited. She claimed that people operating in free and transparent markets are capable of figuring out how and where to execute trades without regulatory mandates. She also emphasized that any changes to Rule 611 must be considered alongside related rules, including "access fee caps, the prohibition on locked and crossed markets, the fair access rule, the SIP revenue allocation model, [and] FINRA's best execution rule."
Ms. Peirce noted that while opinions differ on how well "current market structure serves investors, one trend is undeniable: [the dynamic of rising] off-exchange volumes" and proliferating exchanges "points to misaligned incentives and suggests the need for reform." She said the distinctiveness of U.S. equity markets "means that lessons from other jurisdictions may not always be instructive--particularly [regarding] best execution and volume thresholds."
SEC Commissioner Uyeda pointed out that Regulation NMS "coincided with shrinking displayed size," increased execution venues, and "complex routing behavior." He agreed that changes to Rule 611 could require the Commission to reassess the "best execution regime." He asked whether broker-dealers' best execution obligations presuppose compliance with Rule 611 and whether additional requirements would be needed if the rule were altered.
Commentary
It is not often that, having made blunt and detailed predictions that were disregarded at the time, one gets not only to say "I told you so," but also to undo the failures. Chair Atkins has that opportunity.
The Trade-Through Rule will hold on for a bit longer, rules of such complexity cannot be quickly rescinded and the entities that benefit from the rule will fight a rear-guard action. But it will just be a delaying action.
Firms and investors should consider what they want the new rules, or absence thereof, to look like.