Gensler Targets Payment for Order Flow, Other Equity Market Structure Reforms

June 14, 2022

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In a highly-anticipated speech on June 8, SEC Chair Gary Gensler signaled sweeping changes to equity market structure in an ongoing effort to make the equity markets “as fair and competitive as possible for investors.” Technological advances in the markets (such as retail investors having greater access to the markets) have benefited investors, but, according to Gensler, they also face challenges from market segmentation, concentration, and potential inefficiencies, among other things. The SEC’s recent initiatives in this area, including proposals to shorten the settlement cycle and enhance short sales disclosures, and the request for comment on digital engagement practices, are intended to address these challenges.

Gensler has instructed SEC staff to review six areas related to trading in dark pools and through wholesalers. The area that may be of most interest to investment advisers includes payment for order flow, which, according to Gensler, raises potential conflicts of interest. He noted that other countries have banned or are considering banning the practice and has asked the staff to make recommendations on how to mitigate these conflicts. This area of focus also includes exchange rebates (which Gensler says also create conflicts) and related access fees. He has instructed staff to consider how the access fees might change “in light of a potentially lower minimum tick size,” another area for staff review, and how to make exchange fees and rebates more transparent for investors.

The other areas that Gensler has asked the staff to review include:

• Minimum Pricing Increment, or Tick Size. With certain trading venues using one penny tick sizes and others using sub-penny trading, Gensler has asked SEC staff to make recommendations related to harmonizing tick size across market centers, and “possibly shrinking the minimum tick size to better align with off-exchange activity.”

 

• National Best Bid and Offer (NBBO). NBBO is “a quote designed to aggregate information across different exchanges.” With NBBO currently including only round lots when retail investors often trade at odd lot prices, Gensler has asked staff to consider whether the SEC could accelerate implementation of two components of a Market Infrastructure Rule adopted in 2020, including a new round lot definition and enhanced transparency for quotation information with odd lots. Gensler also asked the staff to consider whether there should be an odd-lot best bid and offer.

 

• Disclosure of Order Execution Quality. Gensler discussed enhancing “retail investors’ ability to compare execution quality by their brokers.” He has asked the SEC staff to make recommendations to update reporting requirements to require broker-dealers, in addition to “market centers,” to disclose order execution quality information, such as price improvement as a percentage of the spread, on a monthly basis.

 

• Best Execution. Gensler has asked SEC staff for recommendations on whether the SEC should propose its own best execution rule for equities and other securities. Currently FINRA and the MSRB have rules in this area.

 

• Order-by-Order Competition. Currently most retail market orders flow to wholesalers that pay for the order flow, and they are separated from institutional investors. Gensler has asked SEC staff to make recommendations on how to enhance order-by-order competition and explained that this “may be through open and transparent auctions or other means, unless investors get midpoint or better prices.”

 

The IAA commented on the SEC’s settlement cycle proposal and digital engagement request for comment. The IAA will continue to engage with members on market structure proposals that affect investment advisers.

See “Market Structure and the Retail Investor:” Remarks Before the Piper Sandler Global Exchange Conference (June 8, 2022). See also SEC Staff Report on Equity and Options Market Structure Conditions in Early 2021 (Oct. 14, 2021), available at https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf.