Remarks Before the SEC Historical Society – “The Continuous Process of Optimizing the Equity Markets”

 

As you know better than anyone, the SEC has a tradition of being home to some of the smartest, most remarkable people in government.  The staff of this agency are among the most talented and dedicated people I have ever met.  They are who make the SEC strong and the special place it is.

 

President Theodore Roosevelt once famously said, “It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better.  The credit belongs to the man [or woman] who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly…who spends himself [or herself] in a worthy cause.”[1]

 

And while the Commission has always had its share of critics over the years, they are no match for the tremendous public servants at the agency who have served and do serve in the arena, striving valiantly and successfully in the cause of protecting America’s investors and our markets.  I know we have many current and future SEC alumni here and watching the webcast today, so I would just like to emphasize my gratitude to all of you for your service to and support for this renowned institution and the public interest.

 

As has become the custom here, I will give you a very brief report on some of the current work of the Commission.  As you know, between the implementation of the Dodd-Frank and JOBS Acts, and advancing an important range of discretionary mission critical initiatives, the SEC has undertaken probably the most complex and daunting period of rulemakings in its history.  In that regard, I am pleased to report that in May, we completed all of the JOBS Act rulemakings,[2] and we have now reached the final phase of implementing the Dodd-Frank Act as we work to complete all of the rules in the two major remaining areas on which we made great progress in 2015 and early 2016: security-based swaps and executive compensation.  But, as you know, the SEC’s mission extends far beyond that.  As the markets and investor needs evolve, we must constantly evaluate areas where we can better further our mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.  In other venues, I have recently detailed our progress on the ongoing modernization of the regulatory regime for the asset management industry and our disclosure effectiveness review, and extolled the record accomplishments of the Enforcement and Exam programs.[3]

 

Today, I thought would briefly update you on the status of our equity market structure agenda – not only because it has been a priority of mine and the agency for the past three-plus years, but also because it has been a priority for the Commission throughout its history, and always will be.  That history began, of course, in 1934 with the adoption of the Exchange Act, which for the first time gave our newly created agency sweeping powers over securities trading in the secondary markets, including broad authority over the primary participants in that market:  brokers, dealers, and national securities exchanges.  And since the early twentieth century, the Commission has been engaged in an almost continuous review of equity market structure, constantly seeking ways to improve and optimize its operation.  While I will not attempt a full historical tour today, I do want to mention a few highlights.

 

In 1971, the Commission, for example, issued the Institutional Investor Study, [4]  finding that the markets had become increasingly complex and inefficient, due in part to exchange fixed commission schedules and institutional investor desire to avoid those commissions through direct trading relationships with broker-dealers.  The market fragmentation noted in that study led the Commission to issue a Statement on the Future Structure of the Securities Markets in 1973 that advocated for a centralized market system.[5]

 

In the wake of those Commission actions in the early 1970s, Congress enacted the Securities Acts Amendments of 1975.[6]  As you know, those amendments granted the Commission broad authority to establish a national market system with the specific (and sometimes competing) goals of promoting: (1) efficient execution of transactions; (2) fair competition among broker-dealers, exchange markets, and non-exchange markets; (3) the broad availability of quotes and transaction information; (4) the practicability of brokers executing investors’ orders in the best market; and (5) the opportunity for investors’ orders to be executed without the participation of a dealer.  Despite the significant changes that have occurred in our markets since 1975, these same issues remain as relevant to our market structure today as they were in 1975.

 

The Commission used its new authority in 1975 to facilitate a national market system.  Among other things, it abolished the long-standing fixed commission schedules and facilitated the creation of the consolidated market data plans that are still in use today.  The Intermarket Trading System (ITS), an early predecessor of today’s Order Protection Rule, was also created to link various markets trading listed securities.

 

Of course, the markets evolved in response to these regulatory changes and advancements in technology, and the Commission again took stock of our market structure in the Market 2000 Report issued in 1994.[7]  That study, which was initiated by former Chairman Breeden, analyzed structural issues that had existed in the markets since the passage of the Securities Act Amendments of 1975 and concluded that our equity market structure was sound, having benefited from enhancements in technology and competition that reduced trading costs, enhanced market transparency, and improved liquidity.  It also included suggestions to further improve market transparency, competition, and the fair treatment of investors.  That significant effort led to the Commissions’ order handling rules and the retail execution quality and order routing disclosure rules.

 

The Commission continued its review of equity market structure in a request for comment on market fragmentation issued in 2000.[8]  In that action, the Commission solicited comments on a range of issues that included fragmentation, internalization practices, payment for order flow and best execution, and highlighted several potential options for addressing fragmentation.  That effort culminated in the 2005 adoption of Regulation NMS, a landmark body of rules that govern all aspects of today’s national market system.  Among these rules is Rule 611, the Order Protection Rule, which replaced the outdated ITS and, for the first time, required market participants to honor the best prices displayed in the national market system by automated trading centers.  This established a critical linkage framework for the modern markets.

 

The Commission is now in the midst of another significant phase of market structure review, as technology advancements continue to accelerate the pace of change in how orders are generated and executed.  While these advancements have generally served retail and institutional investor interests well, as I have remarked before, [9] it is critical that we, as regulators, keep pace with these changes with a keen focus on the fundamentals driving them.[10]  We must fully understand the evolving marketplace, identify the issues with precision before making any fundamental changes, and assess the likely consequences that may follow.

 

The Commission’s continuing work in market structure is a substantial undertaking that requires updates in technology, and utilization of data and analytics to make informed decisions on enhancing market structure.  That means new ways of using existing market data through tools like MIDAS, and it also means building new systems to provide even more powerful analytical capabilities for the Commission and our fellow regulators.  That is why we have been moving forward on a proposed national market system plan to create a consolidated audit trail, which will be one of the world’s most comprehensive and sophisticated financial databases.  That plan was put out for notice and comment in April and is expected to be finalized by the end of the year.

 

In addition to focusing on the need for robust data and enhanced regulatory capacity, through initiatives like MIDAS and CAT, I have also prioritized a number of other targeted initiatives to optimize our market structure—namely, ensuring the operational integrity of critical market infrastructures, enhancing market transparency and disclosures, and building more effective markets for smaller companies, to mention just a few.[11]  More will follow.

 

We have made much progress across this agenda by improving market stability through initiatives such as Regulation SCI (Security Compliance and Integrity), which strengthened the technology infrastructure of the market and expanded Commission oversight of that technology.  We have also worked closely with the exchanges to address issues like order types and operations, data feed disclosures, and “single points of failure” within infrastructure systems that have the ability to significantly disrupt trading.  We and the SROs are also actively reviewing the operation of the limit up-limit down pilot plan, with a focus on issues that occurred during the volatile trading of August 24, 2015.  This review has included extensive public analysis by SEC staff of that day’s events and the consideration of specific improvements to refine the plan’s operation.

 

We have also taken action to address enhanced market transparency and disclosure with our proposal last November to update Regulation ATS.  This proposal is designed to shed light on dark pools and bring greater transparency about how ATSs operate, including the material conflicts of interests they can pose for investors and other market participants.[12]  And, as a complement to the Regulation ATS proposal, I expect the Commission to consider very soon a proposal to provide customer-specific institutional order routing disclosures and targeted enhancements to existing order routing disclosures for retail customers.  These two proposals would provide valuable new information to investors about how their orders our routed and executed in today’s markets.

 

We have also taken a significant step to do a data-driven assessment of how our market structure is working for smaller companies.  In May 2015, the Commission approved a national market system plan for a two-year pilot program that will widen the minimum quoting and trading increments for stocks of smaller companies.  This two-year pilot, which is scheduled to begin on October 3, 2016, will provide the Commission with valuable data on whether wider tick sizes would enhance the market quality for smaller company stocks for the benefit of issuers and investors.

 

In early 2015, as part of our broader market structure work, we created the Equity Market Structure Advisory Committee, comprised of diverse experts who consider specific initiatives and potential structural changes.  The Committee was established to assist the Commission in its comprehensive review of the structure of the equity markets, and I have been very pleased with the progress of the Committee’s work over the past year.  It is taking on the core issues that are key to our efforts to optimize our equity market structure.  At their most recent meeting in April, for example, the Committee was presented with draft recommendations from two of their subcommittees for an access fee pilot and trading venue regulatory reforms.  And I expect that the full Committee will vote soon on a formal access fee pilot recommendation.

 

As you can glean from my whirlwind summary of our market structure agenda, the Commission’s work throughout its history to promote fair, efficient and competitive markets continues with energy, thoroughness and the SEC’s characteristic focus on its mission.  As I have said before, our work to optimize the equity markets is never finished.  In order for our markets to remain the strongest and most reliable in the world, regulatory changes must be timely, effective, and informed – and a constant priority.  Our current significant efforts are the latest in the Commission’s historical ongoing work to address the evolving market structure challenges.  And we will continue to work hard and smartly to adapt and grow with the marketplace to better protect investors and to optimize the markets for the issuers who rely upon them.  It is obviously one of the agency’s most important responsibilities.

 

Thank you for listening.

 

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