Potential Reforms on the Horizon for U.S. Equity Market Structure; Palm Beach Attorney Laura Anthony Provides Insight

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May 17, 2019, 05:00 ET

WEST PALM BEACH, Florida, May 17, 2019 /PRNewswire/ -- Recently, SEC Chairman Jay Clayton and Brett Redfearn, Director of the Division of Trading and Markets, gave a speech to the Gabelli School of Business at Fordham University regarding the U.S. equity market structure, including plans for future reform.

Chair Clayton begins his remarks by praising the Treasury Department's four core principles reports. In particular, the Treasury Department has issued four reports in response to a recent executive order requiring it to identify laws, treaties, regulations, guidance, reporting and record-keeping requirements, and other government policies that promote or inhibit federal regulation of the U.S. financial system.

The four reports include thorough discussions and frame the issues on: (i) Banks and Credit Unions; (ii) Capital Markets; (iii) Asset Management and Insurance; and (iv) Nonbank Financials, Fintech and Innovation.

The executive order directed the Treasury Department to issue reports with the following objectives:

Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
Prevent taxpayer-funded bailouts;
Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
Enable American companies to be competitive with foreign firms in domestic and foreign markets;
Advance American interests in international financial regulatory negotiations and meetings;
Make regulation efficient, effective, and appropriately tailored; and
Restore public accountability within federal financial regulatory agencies and rationalize the federal financial regulatory framework.

Chair Clayton and Director Redfearn began with a review of the recently adopted SEC's initiatives related to market structure. In particular, in 2018 the SEC: (i) adopted the transaction fee pilot; (ii) adopted rules to provide for greater transparency of broker order routing practices; and (iii) adopted rules related to the operational transparency of alternative trading systems ("ATSs") that trade national market system ("NMS") stocks. The new rules were designed to increase efficiency in markets and importantly provide more transparency and disclosure to investors.

Clayton and Redfearn then turned to the equity market structure agenda for 2019, which is focused on a review and possible overhaul to Regulation NMS. Regulation NMS is comprised of various rules designed to ensure the best execution of orders, best quotation displays and access to market data. The "Order Protection Rule" requires trading centers to establish, maintain and enforce written policies and procedures designed to prevent the execution of trades at prices inferior to protected quotations displayed by other trading centers.

The "Access Rule" requires fair and non-discriminatory access to quotations, establishes a limit on access fees to harmonize the pricing of quotations and requires each national securities exchange and national securities association to adopt, maintain, and enforce written rules that prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross automated quotations. The "Sub-Penny Rule" prohibits market participants from accepting, ranking or displaying orders, quotations, or indications of interest in a pricing increment smaller than a penny. The "Market Data Rules" requires consolidating, distributing and displaying market information.

In recent roundtables on the topics of the market structure for thinly traded securities, regulatory approaches to combating retail fraud, and market data and market access, Chair Clayton and Director Redfearn realized the impact of Regulation NMS on these matters. Each of these topics was then addressed.

Thinly Traded Securities

Regulation NMS mandates a single market structure for all exchange-listed stocks, regardless of whether they trade 10,000 times per day or 10 times per day. The relative lack of liquidity in the stocks of smaller companies not only affects investors when they trade, but also detracts from the companies' prospects of success. Illiquidity hampers the ability to raise additional capital, obtain research coverage, engage in mergers and acquisitions, and hire and retain personnel. Furthermore, securities with lower volumes have wider spreads, less displayed size, and higher transaction costs for investors.

One idea to improve liquidity is to restrict unlisted trading privileges while continuing to allow off-exchange trading for certain thinly traded securities. Similar to market maker piggyback rights for OTC traded securities, when a company goes public on an exchange, other exchanges can also trade the same security after the first trade on the primary exchange. This is referred to as unlisted trading privileges or UTP. Where a security is thinly traded, allowing trading on multiple platforms can exacerbate the issue. If all trading is executed on a single exchange, theoretically, the volume of trading will increase.

Moreover, institutions are particularly hampered from trading in thinly traded securities as a result of Regulation NMS. That is, the Regulation requires that an indication of interest (a bid) be made public in quotation mediums which indication could itself drive prices up. The risk of information leakage and price impact has been quoted as a reason why a buy-side trader would avoid displaying trading interest on an exchange in the current market structure. Read more here.

Attorney Laura Anthony

Laura Anthony, Esq. is the founding partner of Anthony, L.G., PLLC, a national corporate, securities and business transactions law firm. For more than two decades Ms. Anthony has focused her law practice on small and mid-cap private and public companies, capital markets, NASDAQ, NYSE American, the OTC markets, going public transactions, mergers and acquisitions, registered public and exempt private offerings and corporate finance transactions, Regulation A/A+, securities token offerings, Exchange Act and other regulatory reporting requirements, FINRA requirements, state and federal securities laws, general corporate law and complex business transactions. The Anthony, L.G. PLLC team has represented issuers, buyers, sellers, underwriters, placement agents, investors, and shareholders in mergers, acquisitions and corporate finance transactions valued in excess of $1 billion. ALG has represented in excess of 200 companies in reverse merger, initial public offering and direct public offering transactions. Palm Beach Attorney Laura Anthony is also the creator and author of SecuritiesLawBlog.com, the host of LawCast™, Corporate Finance in Focus and a contributor to The Huffington Post, Law360 and the ABA Journal.