The deadline for submitting comments on Securities and Exchange Commission Chair Gary Gensler’s controversial proposal to partially overhaul the US trading system has ended. His idea is so far reaching and complex that it has been split into four individual proposals, with two having significant industry support while the other two face opposition.
One proposal aims to replace payment for order flow with an auction process – a response to the GameStop meme stock short squeeze in early 2021. That change is reportedly generating a huge number of comment letters. While retail investors largely support the proposal, the industry is against it, citing potential market disruption and higher costs for retail investors. Some are even threatening litigation if the proposal is approved. It is the most controversial of Gensler’s proposals. He has been critical of payment for order flow, a practice where some retail brokers route orders to wholesaler market makers. They, in turn, pay the brokers for access to order flow. Wholesalers may send the orders to exchanges, but will often match the orders against their own internal order flow.
Wholesalers profit on the difference between the buying and selling price. Because brokers receive fees from the wholesalers on these transactions, the practice allows brokers to charge zero commission to clients.
Gensler, though, claims institutional investors and pension funds are not able to interact with retail order flow. He also argues that brokers put their own financial interests ahead of their requirement to ensure their clients get the best prices. His plan is to create an auction system that forces wholesalers to compete with each other to deliver the best price to the investor.
Wall Street opponents say Gensler’s idea is so complex and difficult to assess in terms of cost that it could lead to market disruption.
Another proposal aims to allow trading in sub-pennies, a move that has industry support. Right now, the NYSE and Nasdaq cannot execute a trade at anything less than a penny increment (with some exceptions such as penny retail programs), but market wholesalers can trade in any increment, including hundredths of a penny.
Gensler argues that this creates an advantage for off-exchange market centers. His proposal would require one minimum trading size.
The third proposal requires market participants to disclose more specific information on how well they are executing trades for their clients.
Finally, a new rule called Regulation Best Execution is proposed to establish a national standard to ensure broker-dealers send orders to the venue that will get the best price for buyers and sellers.
FINRA already has such a rule. There’s also a rule for municipal securities broker-dealers overseen by the Municipal Securities Rulemaking Board (MSRB).
Gensler says the SEC needs its own rule.
“I believe a best execution standard is too important, too central to the SEC’s mandate to protect investors, not to have on the books as Commission rule text,” he wrote in a December 2022 comment letter about the proposal.
The SEC will now review the comments on all four proposals and could either reopen the comment period, tweak the proposals, drop one or more of the proposals, or proceed to the final rulemaking stage. The proposals are complex, so it is unlikely that a vote will take place in the near future.