The time has come to reform America’s stock markets. That was the message from Robert Jackson of the Securities and Exchange Commission during a speech Wednesday at George Mason University.
Regulators, he said, must remember that market participants will follow the economic incentives given to them. “Given power and a profit motive, even the most storied institutions will do what they must to maximize their wealth,” he said. “Nowhere has this been more true than in our stock markets.”
For over a century, stock exchanges were collectively owned by not-for-profits, overseeing and organizing trading in America’s best-known companies. About a decade ago, however, they “became private corporations, designed—perhaps even obligated—to maximize profits,” Jackson said.
“Yet we at the SEC have far too often continued to treat the exchanges with the same kid gloves we applied to their not-for-profit ancestors,” he added. “The result is that, even while one of our fundamental mandates is to encourage competition, the SEC has stood on the sidelines while enormous market power has become concentrated in just a few players.”
That’s a key reason, he says, why among our 13 public stock exchanges, 12 are owned by just three corporations and “developed puzzling practices that look nothing like the competitive marketplaces investors deserve.”
His assessment: “What is clear is that their profit motive gives exchanges every reason to structure stock markets in a way that maximizes their rents. And every time exchanges raise prices, that money comes out of the pockets of investors, who pay more to buy and sell stocks than they otherwise might. The elaborate stock-market structure we have today isn’t free; American investors are paying for it, one microsecond a time.”
A day after Jackson’s remarks, both the Dow Jones Industrial Average and S&P 500 set new all-time highs.
Jackson conceded that the SEC has “struggled to keep up” and its oversight of the stock markets has drawn criticism from market participants, the federal courts, and others who wonder if it allows conflicts of interest in this area to persist.
“That’s why I’ve come here today to say that it’s time to put the “exchange” back in the Securities and Exchange Commission,” Jackson said.
So, how is the current, post-Exchange Act world problematic? One example, offered by Jackson, is rules requiring orders to be routed to the exchange that displays the best national best bid or offer.
The Commission has capped the fees the exchanges can charge. “But facing a limit on one kind of fee, exchanges may have simply raised other fees, like the cost of connecting to the exchange,” he said. “And because our rules require orders to be routed in this way, we risk that the law—rather than market forces—drives the price investors pay to connect.”
Another concern: “We have created a two-tier system of stock-price information—a lower-quality public feed and generally higher-quality private ones. And we allow the exchanges to run both.”
In 1975, Congress mandated that a universal, public feed of stock exchange prices be available for purchase by all investors, Jackson explained. “These prices are the lifeblood of our equity markets, because they tell investors what stocks are worth at any given moment. Investors demand, and the law requires, that they receive the benefit of these prices when they buy and sell stocks.”
“Importantly, however, the exchanges run the public feed. And, at the same time, the exchanges sell private data feeds,” he added. “The result has been a public feed that is slower and less robust than the private feeds the exchanges sell.”
Unsurprisingly, he said, exchanges have underinvested in the public feed, a product they compete with. “It’s like letting Barnes & Noble run our public libraries. Nobody should be surprised to find that our libraries don’t have enough books,” Jackson said.
Another problem, he said “is that treating for-profit exchanges with not-for-profit kid gloves [and self-regulatory status] has allowed stock exchanges to operate, in many respects, above the law.”
Jackson sees likely Commissioner-led fixes on the horizon. Among them: a pilot study that will test the effects of rebates on market conditions; increased transparency about how exchanges make their money; a clear and uniform approach to disclosing revenues across exchanges; rulebooks that impose low liability limits even when exchanges are found liable for investor harm will receive closer scrutiny; and the results of recently announced roundtables regarding equity market structure.
“My office will be especially focused on the roundtable on market data. It is time for the Commission to have a market-wide conversation about how exchanges make their rules and prices,” Jackson said.