The Securities and Exchange Commission is exploring an overhaul of US stock market rules to strengthen competition and ensure individual investors are fairly treated after the explosion in retail trading during the coronavirus pandemic.
The regulator has been reviewing equity market structure since last year, when chair Gary Gensler said the meme-stock frenzy — when traders organised online to drive up the shares of a handful of companies — highlighted “inefficiencies” in the market.
Gensler has settled on several potential proposals, according to two people familiar with the matter, including the creation of an auction system designed to increase competition between services for retail investors.
He is expected to outline some of the plans at an industry conference on Wednesday, the people said, with formal commission proposals to follow in the summer or early autumn. The SEC did not immediately respond to a request for comment.
The plans are likely to be welcomed by exchanges such as Nasdaq and the New York Stock Exchange, which have been lobbying for a more level playing field to compete with off-exchange trading groups such as Citadel and Virtu Financial. But they will raise concerns among broker-dealers, some of whom fear changes to the system could drive up costs.
The most radical change that has been discussed with exchanges and institutional investors in recent weeks is the introduction of an auction mechanism to decide which trading groups get to handle retail investors’ orders. Under the current system, brokers can send orders directly to individual firms, which sometimes pay brokers for directing flow to them.
In exchange, trading firms promise to provide retail investors with a slightly better price than the market quote. But opponents said the system did not help investors and it is already banned in some countries.
The SEC is not expected to explicitly ban so-called payment for order flow, but it is considering a proposal regarding “best execution”, the principle that governs the way brokers route customer orders, which could make it harder for a broker to justify accepting payments. Brokers take direction on best execution from the Financial Industry Regulatory Authority, an industry watchdog.
Gensler is also considering letting stock exchanges quote stocks in increments of less than 1 cent, and harmonising the tick size — the minimum price movement in which quotes can move — between exchanges and off-exchange venues.
Exchanges have been lobbying for such changes for years as they gradually lost market share to rivals that are less heavily regulated. Off-exchange trading as a percentage of total US equity volume has increased from less than 25 per cent in 2009 to a peak of 47 per cent at the height of the retail trading boom last year.
The plans are part of a broader push by the SEC under Gensler to reform areas ranging from the behaviour of activist investors to how companies report about their impact on climate change. The flood of proposals has prompted complaints and plans for legal action from many investment firms and lawyers.