One Of Gary Gensler's Most Controversial Proposals Is Facing Opposition From Wall Street

Today is the last day for the trading industry and investors to submit comments regarding one of the most controversial proposals proposed by Securities and Exchange Commission Chair Gary Gensler: a partial overhaul of the system for trading in the U.S. today is the deadline for comments.

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Gensler has divided the package into four separate proposals because it is so complex and potentially far-reaching that they are split into four separate proposals. There is some industry support for two of these proposals and they will likely be adopted. Nevertheless, two others are facing serious opposition, and one of them — the attempt to replace payment for order flow by an auction process resulting from the GameStop meme stock controversy — could ultimately end up in court to prevent it from being implemented. 

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Do small investors trade at better prices? 

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A proposal involving a change in the way some retail orders are handled is the most controversial of the proposals. There have been some criticisms directed at the concept of payment for order flow (PFOF), whereby some retail brokers (such as Schwab, ETrade, and Robinhood) route orders to wholesalers, electronic market makers (such as Citadel and Virtu), who pay the brokers in return for access to these market makers' orders. The wholesalers are often referred to as wholesalers, but they also match their orders to their internal order flow, before sending them to the exchange. 

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The wholesalers benefit from the difference between the buying and the selling price rather than commissions being charged to their clients, because the wholesaler's profit from the difference between the buying and selling prices. 

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There is one issue, however, that Gensler has raised as well. He has claimed that pension funds and other institutions of investors are not able to interact with the retail order flow. He also maintains that the broker's focus has been placed above providing their clients with the best possible price. 

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Gensler hopes that this increased competition will take place through the creation of auctions in which trading firms will compete against one another for filling investors' orders before they are executed internally by their entities. 

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Even though many market participants compete to execute their marketable orders at the best price possible, these daily individual investors do not have the full benefit of this competition, Gensler stated in a December statement. Compared to the current practice, Gensler claims investors can save approximately $1.5 billion annually. 

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In the face of auctions, the industry is aligned against them

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There have been a large number of comments to the SEC regarding the auction proposal. 

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Many individual retail investors have submitted submission letters in support of the proposal. A large number believe that payment for order flow was one of the factors that contributed to the events surrounding Gamestop, AMC, and other so-called meme stocks in early 2021, and many believe that it was a relatively common problem. 

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The Better Markets, an independent nonprofit that promotes public interest in financial reform, said in a recent blog post on its website that these proposals could serve as crucial steps in addressing the issues we observed in January 2021 and making the market fairer for retail investors. 

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However, the majority of Wall Street disagrees with this view vehemently. 

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This proposal has so much complexity and the costs are so hard to estimate, that there is the possibility of significant disruptions to the market as a result. 

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In a statement to Trade Algo, Kenneth Bentsen, the President and CEO of the Securities Industry and Financial Markets Association (SIFMA), said in a statement that members of SIFMA believe that the order competition rule should be withdrawn. The Securities Industry and Financial Markets Association is a trade association that represents investment banks, asset management companies, and securities brokerage firms. 

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Rather than make a compelling case for doing this, the SEC failed to do so, and Bentsen argued that it would not only disrupt the market but will also hurt those stakeholders for whom the SEC purports to care. Furthermore, the SEC's cost/benefit analysis is flawed, indicating that enacting this proposal will result in a significant increase in retail investor costs if it is enacted. According to several academic research studies, this proposal will result in increased costs for retail investors. There are several factors contributing to the U.S. equity markets' efficiency and resilience, including the greatest ease of access for investors, the lowest trading costs, and the most excellent executions ever experienced by investors. Especially for retail investors, there is intense competition in the market both upstream and downstream. This flawed proposal may do more harm than good, and it is based on outdated data that does not accurately reflect the current state of the market. 

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There is also a joint letter from NYSE, Citadel, and Charles Schwab that recommends that the proposal be withdrawn entirely, as well as another joint letter from Cboe, State Street Global Advisors, T. Rowe Price, UBS, and Virtu Financial, which also recommends the proposal be withdrawn entirely. 

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According to the joint Cboe letter, the Commission should not proceed with its proposed legislation mandating equity auctions for marketable retail orders, as they believe the proposal will not be effective. According to the letter, the SEC should consider alternatives to improving execution quality "that do not adversely affect competition, liquidity, and efficient capital formation in our equity markets to enhance execution quality." 

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In response to the proposal, Nasdaq has also expressed concern over the proposal. It said that the SEC is at risk of exposing itself to too great danger by only focusing on qualified auctions, and urged the SEC to establish a minimum threshold for price improvement for broker-dealers to meet for retail order flow to be internalized. 

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In addition to Shester Peirce, both Republican commissioners of the SEC, Mark Uyeda did file statements opposing the proposal as well. 

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Peirce, in a statement, wrote that the latest attempt to order competition poses a risk of creating disorder in the capital markets, the functioning of which is critically important to the rest of the economy as a whole. 

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Even though we are considering extensive changes, she argued that we have not completed the necessary work to justify them. 

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Are you prepared to take your case to court? 

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As a result of the proposal, some companies are already threatening to file lawsuits if it is approved. 

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“The result could well be litigation, unfortunately, if Gensler chooses to proceed down this path,” Virtu CEO DougCifu told an audience at the Securities Traders Association of New York conference held on March 27th at the New York Stock Exchange, in an interview after the conference ended for the day. 

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A specific reference was made to the Administrative Procedures Act (APA), which mandates how governments may establish regulations and propose them to the public. 

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A violation of the APA will result in the SEC being sued if it does not follow the instructions outlined in the APA. 

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There are several dimensions to a potential lawsuit against the APA, according to a securities attorney with knowledge of the APA that asked to remain anonymous. 

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The attorney explained that he believed it would be unlikely in this case that such a challenge would succeed and that the most effective way to challenge an agency is to say that they are doing something outside of its statutory authority. 

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Additionally, the attorney noted that two types of challenges could be made under the APA. The first is a procedural challenge. You could say that the SEC lacked adequate notice or opportunity for me to participate in the discussion. Often, when the SEC relies on data or information they are not making public, you can make that type of claim. 

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The most common claim against the SEC regulation is that it is arbitrary and capricious. "You can claim that the SEC did not consider several factors relevant to its decision, you can claim it did not recognize any reasonable alternatives, or you can claim it did not consider the comments of the public." 

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Another almost certain argument the SEC will make is that the cost-benefit analysis has been inadequate and that the proposal does not pay off. This will almost certainly be a point of contention in any lawsuit, and it will almost certainly be the case that the SEC failed to adequately consider the costs of the proposal. 

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A corporate lawyer whose firm serves as the general counsel for the company refused to comment on whether a lawsuit was likely to be filed. However, another lawyer familiar with the submissions made by this company and who also asked to remain anonymous, explained that the submissions are part of an ongoing litigation process. 

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Are you ready to trade sub-pennies? 

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In a second proposal being considered, it is possible that the minimum trading increments could have also been changed from one penny nearly 20 years ago. 

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A trade on exchanges such as the New York Stock Exchange and Nasdaq can usually only be executed with a penny increment (or a midpoint) under current regulations; however, market wholesalers (dealers internalizing their orders) are allowed to trade in any sub-penny increment, including one-hundredth of a penny. The dark pools, which are trading venues that are located off of the stock exchange, also offer sub-penny increments but are not permitted to execute them. 

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There has been a significant improvement in trading conditions for these off-exchange markets over the years, according to Gensler. Gensler is proposing to require only one minimum trading size regardless of the location of the market center. 

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To meet Gensler's proposal for making the minimum increment smaller than a penny for many securities, I would like to know the size of that increment. 

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It has been known for quite some time that many stocks have a bid-offer spread that is one cent wide. That is, the price of the stock is almost always one cent wide. So why start trading at a penny interval? In other words, investors would likely be able to get better prices if ticks were smaller than a penny. 

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Depending on what specific securities you are referring to, the tick size of a share, such as a 10-cent share, would be reduced to a tenth. Securities that are tick-constrained may have even smaller tick sizes, such as a half-cent share. 

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Are you satisfied with the execution of your trades by your broker? 

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Toward the end of the third proposal, market participants would be required to disclose more information about how well they are performing when executing trades for their clients. 

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Several market participants (exchanges, dark pools, and wholesalers) are required to submit monthly reports outlining the quality of the execution of client orders every month. This rule, known as Rule 605, has been criticized by Gensler as it has not been updated since it was adopted in 2000, and it is noted that the requirements have not been updated since then. According to him, investors of today need an increased understanding of how well their trading orders are being executed. 

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A major concern Gensler has is that he wants to provide investors with more information about how trades are executed, and he wants these reports in a format that everyday investors can understand and follow. 

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As a second point, Gensler wants to include large broker-dealers in addition to market centers in the group responsible for issuing reports on execution quality in the manner. 

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The proposal to amend the Securities and Exchange Act of 1934 would give investors easy access to information that details just how well their brokers are performing for them, Gensler advised in a statement issued in response to the proposal. 

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SEC wants to set its own rules for the best execution 

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Additionally, to add more information on how well firms are executing orders, Gensler is presenting a proposal to establish a national best execution standard by establishing Regulation Best Execution, which will ensure brokers-dealers send orders to the right venue that will provide buyers and sellers with the best possible price. 

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As a self-regulatory organization (SRO) that regulates broker-dealers, the Financial Industry Regulatory Authority (FINRA) already established rules on best execution, and those rules already apply. As an added benefit, the Municipal Securities Rulemaking Board (MSRB) has adopted a separate rule in 2016 for brokers-dealers who deal with municipal securities. 

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It is Gensler's belief, however, that the SEC needs its own set of rules in this regard. 

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"In my opinion, the best execution standard is too important, too central to the SEC's mandate to protect investors, to be left out of the Commission's proposed rule text when the proposal was first considered last December," he said in a comment letter he sent when the issue was first considered.

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It is unclear what the consequences of an additional SEC rule would be. Gensler suggests an additional rule would "improve investor protection by providing for an enhanced enforcement capability, which would include the ability to enforce the new rule and bring remedial actions against those who violate it." 

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The SEC will be able to sue potential violators of its own rules by having its own set of rules. 

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In relation to the proposals, where does Wall Street stand? 

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While Wall Street firms seem to generally oppose the idea of an auction, the same cannot be said for other plans put forward by the government. 

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As far as the proposal to allow trading of stocks at a half-penny spread or tenth of a penny is concerned, industry support appears to be unanimous. However, there is disagreement about which stocks should be traded at that level. According to the comments submitted by NASDAQ, Citadel, and Charles Schwab, the idea of reducing the minimum quoting increment from a penny to anywhere between a half-penny and a tenth of a cent is generally supported. 

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There was also support in the same comment letter for improving the quality of execution information. 

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As for the Regulation Best Execution proposal, there is considerable opposition to it, however. Citadel, NYSE, and Charles Schwab, in their comment letter, recommended the proposals be withdrawn entirely, rather than rewritten, claiming both the FINRA and MSRB already have the best execution rules, and that SEC's regulations would be unnecessary and confusing as they would be redundant. This was also stated in the letter signed by Cboe, State Street, T. Rowe Price, UBS, and Virtu, which stated that the regulation was unnecessary. 

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How will things turn out?

Since the comment period has ended, the Commission will now be reviewing all four proposals. It is likely to take several months for the Commission to review all comments. As a result, it can make a variety of decisions. For example, it can 1) reopen the comments period, 2) tweak the proposals, and if they are substantial, send them out for additional comments, 3) drop one or more of the proposals, or 4) go ahead with the final rulemaking process. 

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The SEC could theoretically vote on any or all of the four proposals in a shorter time frame, but the proposals (particularly the auction proposal) are so complex that that is unlikely to be the case. Gensler and the Democrats have a 3-2 majority on the SEC, but not all of the proposals are complex. 

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There is still a lot to be done 

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This is just the beginning of a long line of new proposals before the SEC that will be addressing a wide range of issues, including those that relate to climate change disclosure, human capital management, board diversity, cybersecurity risk governance, data privacy, share buybacks, and many others. 

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Gary Gensler is the new chairman of the Securities and Exchange Commission, and one of the primary themes emerging from Gary Gensler's tenure is the idea that corporate America needs to disclose more of its activities. Gary Gensler believes that this would increase market transparency and, in some cases, make markets more competitive. 

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Herein lies the disagreement: you have to determine when the cost of providing more transparency becomes too great to equal the benefits of providing more transparency. 

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According to Kenneth Bentsen, CEO of SIFMA, at the beginning of our conversation, I asked him about his views on efforts to make the markets more competitive and he said, "We think that markets are very competitive,".

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