Wall Street is unhappy with a government plan to revamp how small investors’ trades are done, and speakers at an industry conference slammed the proposal.
Securities and Exchange Commission Chair Gary Gensler has suggested that brokers send small orders to auction, instead of the prevailing practice of routing them to computerized market makers like Citadel Securities and
Virtu Financial
(ticker: VIRT). At a New York meeting of the Securities Industry and Financial Markets Association Thursday, panelists from all sides of Wall Street condemned the auction idea.
Stock trading doesn’t need a major overhaul, said Bart Green, who runs equity trading at Wells Fargo Advisors. “Retail investors are receiving exceptional execution and low cost trading,” Green told the Sifma audience. “I’m really not aware of any fundamental issues in the marketplace today that need to be addressed immediately to improve the transaction experience for retail clients.”
Gensler set off industry alarms in June, with a speech proposing half a dozen reforms of Wall Street’s trading infrastructure. His ideas included changing the pricing increments for stock quotes and trades, improving brokers’ disclosures on trading performance, and the novel idea to send small orders to auction. The SEC has said these ideas may appear as formal proposals before year end.
The auction idea stems from Gensler’s skepticism that investors benefit from the way stocks are traded today. The majority of orders still go to large exchanges like the
Nasdaq
(NDAQ) and the New York Stock Exchange unit of
Intercontinental Exchange
(ICE). But in the past decade, a third or more of all trades have gone for execution at off-exchange market makers like Citadel Securities. These are mostly orders from individual investors—or “retail” traders—sent by discount brokers like
Charles Schwab
(SCHW). The market makers pay brokers for the order flow — another practice that Gensler would consider banning, as a conflict-of-interest.
Brokers and market makers say their trading arrangements benefit retail traders by getting them better prices than those quoted at exchanges. Studies by academics, and publications like Barron’s, support these claims.
But Gensler has suggested that public price quotes don’t reflect the best prices an investor might get. News reports indicate the SEC will propose that retail orders below a certain dollar amount go to a centralized auction, where dealers, on- and off-exchange, would compete to offer the best price to each order.
The most direct effect of Gensler’s auctions would be to lop off a big chunk of the trading volumes enjoyed by the so-called “wholesale” market makers like Virtu and Citadel Securities. It was no surprise, therefore, to hear those firms question the notion at Thursday’s Sifma meeting.
Auctions work well as the way that exchanges handle the opening and closing of a day’s trading, said Joe Mecane, who heads execution services at Citadel Securities. But Mecane said he’s seen no evidence that order-by-order auctions will attract many competing firms competing for retail trades. Options markets conduct such auctions, but few firms compete for them, he said.
Sapna Patel, who heads market structure and liquidity strategy at Morgan Stanley, also had reservations about order-by-order auctions. “The order should at least be guaranteed an execution,” she said. “If you send a single order into these auctions and no one show up…What happens to that order?”
Patel and others pointed out that information about such failed auctions might leak out and lead to dealers moving their price quotes—and dooming the retail traders to worse prices than they would have gotten under today’s structure.
She reminded listeners that the auction notion had also come in for criticism at a September roundtable held by Sifma in Washington, D.C. “I didn’t see a single participant around the table that was supportive of it,” Patel recalled. “And that’s very telling, when you look at the different hats that we wear.”
There was one proposal of Gensler’s that most of Thursday’s speakers applauded. It’s the idea of expanding the industry’s reports on its retail trading performance — known as Rule 605 disclosures. The rules are 20 years old and leave investors unable to compare the trade pricing they get from different stockbrokers—a challenge that Barron’s undertook in a 2015 data analysis of the 605 reports.
“A number of folks in this room have advocated for a 605 reform,” said Adrian Griffiths, head of market structure at the MEMX exchange. “That’s something that we’d all agree is way overdue.”
The thinking of Gensler and his agency will become clearer when the SEC issues its proposals on equity market reform, in the next month or two.
“I worry about that,” said Morgan Stanley’s Patel. “A thousand pages dropping, right before the holidays.”
Corrections & Amplifications
Joe Mecane heads execution services at Citadel Securities. The original version of this article misspelled his surname.
Write to Bill Alpert at william.alpert@barrons.com
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