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From Securities Regulation Daily, August 2, 2016

Equity market structure subcommittees present market quality, customer issues recommendations

By Amanda Maine, J.D.

SEC Chair Mary Jo White welcomed members of the Equity Market Structure Advisory Committee and the invited panelists, opening a discussion on the recommendations of its market quality and customer issues subcommittees. She noted that the market quality subcommittee’s recommendations are based on an assessment of the August 24, 2015 market disruption and reflect concerns that a market-wide halt in trading would have exacerbated the event. Regarding the recommendations of the customer issues subcommittee, White welcomed the opportunity to discuss broader improvements to existing retail disclosures under NMS Rules 605 and 606.

Commissioner Michael Piwowar also expressed gratitude for the work of the subcommittee members. However, he questioned the recommendation of the customer issues subcommittee that the SEC benchmark and monitor investor confidence in the U.S. equity market structure. Instead of promoting investor confidence, Piwowar said, the Commission should encourage a "healthy dose of investor skepticism," including urging investors to ask questions about how their orders are treated and whether that is consistent with their own investment goals.

Commissioner Kara Stein voiced her concern with the market quality subcommittee’s decision to suspend further discussion on the topic of the quality of markets for small to midsize companies. The subcommittee had concluded that most small cap companies they consulted were more concerned with issues such as the high cost of taking a small cap company public, rather than market structure. According to Stein, market quality and liquidity are important for smaller companies to access capital, and said she hopes that the subcommittee would reconsider its position.

Market quality subcommittee recommendations. The market quality subcommittee recommended that instead of halting the trading of a stock "stuck" in the limit up/limit down (LU/LD) mechanism, a two minute monitoring period would be triggered, during which trading could continue within the limit price. Committee members and panelists generally agreed with this recommendation due to the disruptive nature of halting the market. Venu Palaparthi of Virtu Financial used a technology metaphor to describe the process, explaining that a "refresh" is better for the markets than a "reboot."

Regarding market-wide circuit breakers, the subcommittee recommended that the circuit breaker be widened from 7 percent to 10 percent. Many attendees agreed that the circuit breaker band should be widened, but not necessarily to 10 percent. FINRA CEO and Chair Richard Ketchum said he believes the band should be moved up soon, but he was unaware of any quantitative analysis supporting the 10 percent figure. Committee member Chester Spatt of Carnegie Mellon also noted that the subcommittee had not provided a compelling case for widening the bands from 7 to 10 percent. John Zecca of Nasdaq advised that circuit breakers are like oxygen masks on an airplane: it’s comforting to know they exist, but can be panic-inducing when deployed, so their use should be rare.

Several committee members agreed with Stein that the subcommittee should reconsider its decision to stop work on small and medium companies. Zecca said that there are many emerging growth companies listed on Nasdaq with concerns about the structure of equity markets. Spatt, however, agreed with the subcommittee’s position, stating that market structure is a "second order" concern for small cap companies, which are more concerned with "first order" issues such as the costs of operating as a public company.

Customer issues subcommittee. Regarding the customer issues subcommittee recommendation on benchmarking investor confidence in market structure, some attendees sided with Piwowar in questioning the usefulness of such a survey and how it would affect the work of the Commission. Gary Stone of Bloomberg Tradebook said he would prefer the SEC to use its resources on its Market Information Data Analytics System (MIDAS), which collects market data, research, and analysis that is generally unavailable from the public consolidated tape. Maureen O’Hara of Cornell University also questioned whether the survey could have unintended consequences. If the results of the survey indicate that 40 percent of those surveyed believe that the markets are rigged, it might influence the opinion of the other 60 percent, leading to further deterioration in investor confidence in the U.S. market structure.

Andrew Lo, a member of the customer issues subcommittee, defended the inclusion of the confidence benchmark in the recommendations. He stressed that, as proposed, the survey would not be focused on general investor sentiment of current market conditions, but how investors feel about the integrity of the market structure itself and whether they feel it is rigged, too volatile, or unfair.

The subcommittee’s second recommendation is to modify NMS Rules 605 and 606 to provide meaningful execution quality and order handling disclosures from a retail perspective, including expanding the scope of Rule 605 by requiring broker-dealers provide reports on order execution. Most members and panelists welcomed this proposal, citing gaps in disclosure requirements. Panelist Bill Alpert of Barron’s reported on a study where he examined order execution information that is currently voluntarily provided on some broker-dealer websites, concluding that disclosure improves behavior. "When everybody’s looking at your fitbit score, you work harder," he said.

Attendees also discussed the recommendation that the SEC should consider centralizing reporting in an unbiased and trusted source. Chris Nagy of Healthy Markets noted that such information is scattered on hundreds of diverse websites, leaving it accessible only to firms with the most resources. He said a central source could be modeled on FINRA’s OTC trading information, which is available on its website. Nagy also urged the Commission to abandon the distinction between retail and institutional orders in its recent proposal to amend Rule 606.

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