Senator Urges Rapid, Broad Review of Market Structure Issues

The Securities and Exchange Commission needs to undertake a “comprehensive, independent, zero-based regulatory review” of a broad range of market structure issues before “piecemeal changes to the current market structure” exacerbate potential execution unfairness and make matters worse, says U.S. Sen. Edward E. Kaufman (D-Del.).

In a letter sent Monday to SEC Chairman Mary Schapiro, Kaufman said he is concerned that questionable practices will “further erode investor confidence in our financial markets” because regulatory actions have failed to keep up with changes.

“For the markets to have credibility, the SEC must act urgently to restore a level playing field for investors,” Kaufman said.

The SEC must “look quickly” into three problem areas, he said.

First, whether certain execution strategies are taking advantage of retail investors due to "latent disparities" within the market; whether the more than 50 electronic execution venues are being monitored and audited for best execution; and whether the national best bid and offer (NBBO) truly reflects the quotes consolidated from the various venues at current execution speeds.

While acknowledging that market fragmentation and high-speed trading have produced benefits, Kaufman said that these have centered on the most active stocks, while “liquidity is still light and spreads are still wide on many lower volume stocks, reminding us that providers of liquidity follow the profits in that activity – they do not provide liquidity across all stocks as a service to the market or as a public good.”

Kaufman said he is concerned that SEC rules favor high speed liquidity over execution fairness.

Last Friday, he said that in a universe of over 5,000 U.S. equities, only four stocks – Citigroup, Bank of America, Fannie Mae and Freddie Mac – accounted for 20 percent of the volume.

“This has led to increased competition for market share that now includes questionable practices such as liquidity rebates, flash order offerings, co-location of servers and other inducement arrangements with broker-dealers and other market participants,” Kaufman said.

Kaufman suggested banning flash orders, where some traders are given sneak peaks at orders entering the market; and a "searching examination" of high-frequency trading strategies that take advantage of millisecond advantages in executing trades.

Among the practices he wants examined are: Liquidity rebates, where participants in electronic venues are paid to acquire stocks or "provide liquidity"; incentives to co-locate servers of sophisticated trading firms in the same facilities as servers belonging to exchanges and other "inducement arrangements" involving broker-dealers and other market participants.