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2022 | OriginalPaper | Chapter

5. Fair and Level Playing Fields: A Good Regulatory Goal?

Authors : Amber Anand, Alan Hill, Bill Harts, Nina Mehta, Gary Stone, Adam Sussman

Published in: 40 Years of Experience with the National Market System (NMS)

Publisher: Springer International Publishing

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Abstract

ROBERT SCHWARTZ: My professional colleague, academic collaborator and dear friend, Amber Anand, is our next moderator. It’s always my great pleasure to introduce him.

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Federal legislation of June 4, 1975, to amend the Securities Exchange Act of 1934. The 1975 amendments instructed the Securities and Exchange Commission to cooperate with the industry in creating a National Market System, along with an ambitious system for the clearance and settlement of securities transactions nationwide. The amendments also provided for the prohibition of fixed-commission rates, promulgated earlier by the SEC in its Rule 19b-3.

Ibid.

Wall Street: Underground Combine. TIME. Friday, May 05, 1961.

The Bright Image: The SEC, 1961–1973. Securities and Exchange Commission. Historical Society. http://www.sechistorical.org/museum/galleries/tbi/special_a.php

How a blizzard of paperwork paralyzed Wall Street in the 1960s. https://www.businessinsider.com/wall-street-paperwork-crisis-in-1960s-2015-10

Paper Paralyzed Wall Street: Remembering the 1960s Paperwork Crisis. FINRA Staff. August 19, 2015. When paper paralyzed Wall Street. Remembering 1960spaperwork crisis.

The Depository Tust & Clearing Corporation. http://www.dtcc.com/

Securities Investor Protection Corporation (SIPC). https://www.google.com/search?q=sipc&oq=SIPC&aqs=chrome.0.0j69i59j0l4.4806j0j8&sourceid=chrome&ie=UTF-8

Dick (Richard) Rosenblatt is the CEO and founder of Rosenblatt Securities.

See, About Instinet. https://www.instinet.com/about-instinet/history.html

See, footnote 1.

ADV is the acronym for Average Daily Volume.

Regulation of Alternative Trading System (ATS) was enacted by the Securities and Exchange Commission in 1998. Regulation of Exchanges and Alternative Trading Systems. https://www.sec.gov/rules/final/34-40760.txt

In simple terms, the National Best Bid and Offer, NBBO, requires brokers under US regulation, to guarantee customers receive the best prevailing ask price when they buy securities, and the best prevailing bid price when they sell.

Referring to the historical role of market makers in fulfilling their role as dealers and capital risk takers. On exchanges, or an ATS in many instances, a transaction traditionally was handled by an institutional customer via a dealer buying or selling stock, and often holding and selling inventory based on market supply and demand, and on profit and loss opportunities. By contrast, on other ATS platforms, a transaction is handled directly between institutional customers, so in this sense there is no “interpositioning” by the dealer.

Liquidnet. https://www.liquidnet.com/. BIDS. http://www.bidstrading.com/about/company/

See, the SEC’s Order Handling Rules of 1997 and Beyond: Perspective and Outcomes of the Landmark Regulation RICHARD LINDSEY, JOHN AIDAN BYRNE,AND ROBERT A. SCHWARTZ. The Journal of Portfolio Management. Spring 2016. http://www.iijournals.com/doi/pdfplus/10.3905/jpm.2016.42.3.056

See, Securities and Exchange Commission Archives: https://www.sec.gov/spotlight/emsac/emsac-archives.htm

The California Public Employees’ Retirement System manages pension and health benefits for over 1.6 million California public employees, retirees, and their families.

“That” is referring to the institutions.

“The point was that at some point, the conversation used to be about protecting retail customers from institutional traders,” Anand explained in a follow-up. “By the time of this conference, the focus seemed to have shifted towards HFT, or High Frequency Trading.”

What is Mifid II and how will it affect EU’s financial industry? Far-reaching rules will have a big impact on everything from banks to brokers. Financial Times. September 15, 2017. https://www.ft.com/content/ae935520-96ff-11e7-b83c-9588e51488a0

Night of the living tax: It’s time to bury Ellison’s Inclusive Prosperity Act. Bill Hart. The Hill. February 23, 2017. https://thehill.com/blogs/pundits-blog/economy-budget/320891-night-of-the-living-tax-its-time-to-bury-ellisons-inclusive

Calculated as 0.5 percent on the notional value. Thus with average price of an S&P stock was $80, which would equate then to around 42 cents.

In a follow-up, Bill Hart elaborated: “There should be as little friction or impediment” as possible in the buying and selling interest of each stock, which the market should reflect. “Any time you start talking about taxes and fees, for example, that gets in the way of figuring out the appropriate price,” he said. Factoring in fees and taxes, he added, market makers instead of bidding and offering one cent spreads are, in effect, faced with additional 42 cents spreads in the proposed tax outlined.

The speakers comment here was delivered with sarcasm. He confirmed later that the aforementioned “impediment” would hurt market structure in his view.

Reg NMS (Regulation National Market System) was adopted by the Securities and Exchange Commission in 2005 and introduced two years later to further advance the ideals of a national market system. The regulation includes the order protection, or trade-through rule; access rule (fair access) to market data including quotations; rules on sub-penny trading and on market data.

Laughter was triggered because the speaker represents the block trading platform, Liquidnet, so the exemption would presumably benefit Liquidnet.

Pipeline Trading Systems, aprivate equities and options trading system from 2004 to 2012. In 2011, it agreed to settle an action brought by the Securities and Exchange Commission over charges in the disclosure of the activities of its liquidity providing affiliate between 2004 and 2010. Pipeline was shuttered following the SEC action.

Harborside, offering crossing services, was launched in 2002.

ITG’s POSIT launched in 1987, provides anonymous matching of non-displayed equity orders.

Implementation shortfall is the difference between the decision price and the final execution price, which includes commissions and taxes and any other charges, for a trade. Also known as the “slippage.”

Transaction Cost Analysis (TCA) measures the effectiveness of a portfolio’s transactions in trade executions.

See, About Weeden. https://www.weedenco.com/about-weeden/

In 2006, Liquidnet established H20, an “automated trading system [that] allowed brokers and exchange partners to send retail orders to Liquidnet, a first step in turning the firm into a well-rounded agency brokerage that offered more than matched orders in a dark pool.”

See, Liquidnet’s Merrin Wants Main Street to Dump Wall Street. Frances Denmark. Institutional Investor. March 21, 2012. https://www.institutionalinvestor.com/article/b14zplx0hj0rzb/liquidnets-merrin-wants-main-street-to-dump-wall-street

See, footnote 27.

As Adam Sussman explained in a follow-up, because Liquidet has a limited amount of participants allowed into its system, liquidity is also effectively limited. If a portfolio manager instructs a trader to work an order in Liquidnet in say “5 minutes,” a trader is hardly likely to wait that period of time to work his order. The trader will likely move to other platforms to handle the order.

Also known as the Investors Exchange. The US-based stock exchange was founded in 2012 amidst much fanfare, and is the subject of Michael Lewis’ bestseller, Flashboys: A Wall Street Revolt (W. W. Norton & Company 2014). https://iextrading.com/

“The principle of price/time priority refers to how orders are prioritized for execution. Orders are first ranked according to their price; orders of the same price are then ranked depending on when they were entered.” Source: Marketswiki.com

NASDAQ OMX LAUNCHES FIRST US EQUITY PRICE-SIZE EXCHANGE. NASDAQ Press Release. September 20, 2010. Philly—price-size priority. http://ir.nasdaq.com/news-releases/news-release-details/nasdaq-omx-announces-third-equity-trading-platform-us

The NASDAQ OMX Group, Inc. (Nasdaq:NDAQ), the world’s largest exchange company, today announced that it plans to launch a third equity trading platform during the second half of 2010, pending SEC approval. NASDAQ OMX will offer this equity trading platform with a new price/size priority model using the license acquired from its 2007 acquisition of the former Philadelphia Stock Exchange, known today as NASDAQ OMX PHLX.

A conditional order is a type of order that will be submitted or canceled if set criteria are met, which are defined by the trader/investor entering the order. This allows for a greater customization of the order to meet the specific needs of the investor. Source: Investopedia.

MEMORANDUM: SEC Market Structure Advisory Committee FROM: SEC Division of Trading and Markets1 DATE: April 30, 2015. RE: Rule 611 of Regulation NMS. https://www.sec.gov/spotlight/emsac/memo-rule-611-regulation-nms.pdf

SEC Fact Sheet on Global Analyst Research Settlements. https://www.sec.gov/news/speech/factsheet.htm

Report by Paul Myners, March 06, 2001. https://webarchive.nationalarchives.gov.uk/20070506151732/http://www.hm-treasury.gov.uk/media/2F9/02/31.pdf

Further context, see, Unpicking the research unbundling conundrum. Hayley McDowell, The Trade, April 15, 2019. https://www.thetradenews.com/unpicking-research-unbundling-conundrum/

See, footnote 33.

BATS Global Market and Direct Edge are part of the CBOE Global Markets. http://markets.cboe.com/

Chicago Stock Exchange set to decommission SNAP and outbound routing service. Maria Nikolova. FinanceFeeds. December 20, 2018. https://financefeeds.com/chicago-stock-exchange-set-decommission-snap-outbound-routing-service/

Adam Sussman explained in a follow up that, as he noted earlier on the panel, that if two naturals want to interact, they have to use the pricing in the marketplace; two institutions have to pay attention and abide by the best bid or offer in the marketplace under this, “tyranny of price time.”

Referring to the trading of exchange-listed securities in the over-the-counter-market.

Securities Industry Processor (SIP) See Consolidated Trade Association Fact Sheet: https://www.ctaplan.com/index

See, Investor Alert. Tick Size Pilot Program. What Investors Need to Know. Securities and Exchange Commission. October 03, 2016. https://www.sec.gov/oiea/investor-alerts-bulletins/ia_ticksize.html

See, Flash Boys: A Wall Street Revolt. Michael Lewis (2015, WW Norton & Company, LLC).

See, Wall Street Caves on MiFID, Allows Separate Payment for Research. Benjamin Bain. Bloomberg. January 24, 2020. https://www.bloomberg.com/news/articles/2020-01-24/wall-street-caves-on-mifid-allows-separate-payment-for-research

Unpicking the research unbundling conundrum. Hayley McDowell, The Trade, April 15, 2019. https://www.thetradenews.com/unpicking-research-unbundling-conundrum/

December 2015 was the official deadline for MiFid 11.

Vanderbilt study debunks “phantom liquidity” problem caused by high-frequency traders. Vanderbilt University. July 27, 2017. https://news.vanderbilt.edu/2016/07/27/vanderbilt-study-debunks-phantom-liquidity-problem-caused-by-high-frequency-traders/

See, Once-in-4,800-Year Shock Is Bond Market’s Cold Case Two Years On. Bloomberg. Rebecca Spalding and Eliza Ronalds-Hannon. October 13, 2016. https://www.bloomberg.com/news/articles/2016-10-13/bond-market-s-biggest-cold-case-leaves-questions-two-years-on

The obligation of NYSE specialists to enter the market on a particular security (either by posting or bidding and ask) when there is not sufficient market demand and supply to efficiently match orders. The affirmative obligation required specialists to create a market for a security when public demand or supply is ineffective and cannot create it for itself. Today, the NYSE special has been succeeded by the Designated Market Makers which has altered—and in some cases expanded—their affirmative obligations. Source: Investopedia.

In a follow-up Bill Harts offered this example as an explanation. “Let’s say that the order book is $20 bid for 1,000; $19.00 bid for 5,000. An order then comes in to sell a 6,000 shares market. So technically, the NYSE specialist could execute 1,000 at $20 and 5,000 at $19—a big jump of $1 for just 5,000 shares.

And that would make him look really bad if there was other buying interest ‘in the crowd’ that is not reflected on the book. Say a buyer of 500 at 19.75 and a buyer of 2,000 are 19.50.

To accommodate this extra interest the specialist, back in the day, would often ‘walk the stock down,’ by first executing 1,000 at $20; then asking around the crowd for other buyers, finding the $19.75 buyer; executing that trade, finding the $19.50 buyer, executing that trade, etc.

In conclusion, on the tape the prices posted in this case were $20, $19.75, $19.50, $19. In other words, this was a ‘walk’ rather than a price ‘jump.’”

This refers to the ability of market participants to gain advantages in the speed of their trade executions and the price-quote data through advanced technology, specifically “co-location” of their computer servers near stock exchanges’ computers. That lowers so-called latency, a critical factor in high-speed trade executions. The practice is regarded as legal though it has many critics.

Eurex Exchange. https://www.eurexchange.com/exchange-en/

“Affirmative obligations” refers to the obligations established by an exchange to be a market maker.

“Disclosures from ICE, Nasdaq and Cboe show that their combined stock-market data revenues were around $560 million in 2017, although those don’t include connection fees that traders and brokers pay to access the data.”

“‘Costs for exchanges’ data have grown over the past eight years at a compound average growth rate 11.7%, according to industry consultant Larry Tabb.” Source: Wall Street Journal. Dave Michaels. Wall Street Fractures Over Stock Exchanges’ Data Sales. Some traders say exchanges have a monopoly over certain data, allowing them to charge too much. October 25, 2018. https://www.wsj.com/articles/traders-exchanges-to-square-off-in-market-data-fee-fight-1540465201

A lit market refers to venues that display the various bids and offers in stocks. By contrast, dark markets, or dark pools, do not display prices.

TRACE is FINRA’s system for collecting transactions in corporate bonds and other fixed income instruments from FINRA members and disseminating them to the public.

Volume Weighted Average Price, or VWAP.

Refers to the dark pool volume cap proposals under MiFID in Europe, proposals such as permitting just 4 percent of the total trading in an individual stock in a dark pool. At the time of writing, in late 2019, cap rules had come into effect.

See, NEWTON v MERRILL LYNCH. https://www.leagle.com/decision/2001413259f3d1541400

Market makers may not enter quotes that would lock or cross the market. A locked market is one where the bid and offer are equal in price. A crossed market is one where a bid is entered that is higher than the offer or, one where an offer is entered that is lower than the bid. Source: Investopedia.

Regarding the “ban” on locked and crossed markets, see, To Lock or Not to Lock. Terry Flanagan. MarketsMedia. July 07, 2014. http://marketsmedia.com/to-lock-or-not-to-lock

UPDATE ON OUR EFFORTS TO REVITALIZE U.S. EQUITY MARKETS, APRIL 10, 2019. NASDAQ PRESS RELEASE. https://business.nasdaq.com/totalmarkets

Re-painting the screen is a term adapted by traders for replenishing the display, or redisplaying. For example, let’s say there are 100 shares on display; 500 on reserve. Then, a 100-share order comes in, so the electronic book matches 100 vs display, and then “redisplays 100” leaving 400 shares in reserve.

Referring to the threshold, or volume limits permitted for individual stocks traded on Alternative Trading Systems (ATSs).

See, Island Goes Dark: Transparency, Fragmentation, and Regulation. Terence Hendeshott, Univertsity of Calrifornia at Berkeley. Charles M Jones. Columbia University. January 05. 2005. http://faculty.haas.berkeley.edu/hender/Island_Dark.pdf

Virtual blocks are, in effect, block trades, and a phenomena of advanced electronic trading markets.

https://www.globenewswire.com/news-release/2017/01/10/904859/0/en/TABB-Group-Announces-Spinoff-of-Clarity-Service.html

The speaker is referring to how he is defining a “block” trade. In his view, a block trade needs to occur at a single point in time, that you can’t take multiple executions for one larger order—even if they occurred within a brief period, e.g., a second.

Ibid.

Title: Fair and Level Playing Fields: A Good Regulatory Goal?
Authors: Amber Anand
Alan Hill
Bill Harts
Nina Mehta
Gary Stone
Adam Sussman
Publisher: Springer International Publishing
Book: 40 Years of Experience with the National Market System (NMS)
Print ISBN: 978-3-030-91911-5

Electronic ISBN: 978-3-030-91912-2

Copyright Year: 2022
DOI: https://doi.org/10.1007/978-3-030-91912-2_5

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