The Securities and Exchange Commission is considering changing rules that govern how U.S. stocks are traded, including pricing incentives that exchanges and high-speed traders use to attract orders, Chairman Gary Gensler said Wednesday.
Speaking to an industry conference, Mr. Gensler outlined a broader examination of market structure than he had previously described. Mr. Gensler, who took over the SEC in April, has questioned the system that results in many individual investors’ orders being routed to high-speed traders known as wholesalers, such as Citadel Securities and Virtu Financial Inc., instead of going to public exchanges.
Mr. Gensler suggested individual investors might get better prices if more trading were done on public exchanges. Only about 53% of all trading in January was done on exchanges, while the rest involved wholesalers and broker-run trading venues known as dark pools, Mr. Gensler said.
"The question is whether our equity markets are as efficient as they could be, in light of the technological changes and recent developments," Mr. Gensler told the Piper Sandler Global Exchange and FinTech conference.
While public exchanges disclose their bids and offers and then compile the orders to publish a national best bid and offer for every stock, wholesalers and the so-called dark pools don’t reveal their pre-trade prices. Those off-exchange venues have to execute trades at prices at least as good as the national best price coming from the exchanges.
But the national best bid and offer, known as the NBBO, may be a substandard benchmark, Mr. Gensler said, because so many trades happen away from the exchanges. Even some exchange orders aren’t included in the national best price, such as those in odd-lot sizes, in which fewer than 100 shares change hands.
"I believe there are signs…that the NBBO is not a complete enough representation of the market," Mr. Gensler said.
The SEC will consider revising how the benchmark is calculated, and will examine other potential rule changes related to how exchanges and brokers price shares, he said.
Mr. Gensler has previously criticized a system of trading incentives known as payment for order flow, in which retail brokers send clients’ orders to firms like Virtu and Citadel Securities for a fee. The wholesaler executes the order, typically at a price slightly better than the national best bid or offer.
That price improvement can be a fraction of a cent per share. Exchanges aren’t allowed to price shares at prices of less than a penny. That may give wholesalers an advantage when competing for orders, Mr. Gensler said.
Shares of Virtu dropped about 8% in the minutes after Mr. Gensler’s remarks, though they later pared their losses. Virtu handles between 25% and 30% of individual investors’ order flow in U.S. stocks, and its stock has rallied this year amid heavy trading of meme stocks like AMC Entertainment Holdings Inc. and GameStop Corp. by small investors. Citadel Securities, the only wholesaler with a larger market share, isn’t publicly traded.
The SEC will consider changes to rules governing the minimum price increments, Mr. Gensler said. Any rule changes would first be issued as proposals, giving the ability to investors and other market participants to comment on them. Mr. Gensler didn’t say when the agency would issue a proposal, but said "it should not be confused with something that is far off."
Exchanges also use incentives, known as rebates, to attract orders from brokers. The SEC tried to force the exchanges to experiment with limiting rebates, but a federal appeals court ruled last year that regulators didn’t have the authority to mandate the planned pilot program. The regulator will consider changes to that pricing system as well, Mr. Gensler said.
"Both types of payment for order flow raise questions about whether investors are getting best execution," Mr. Gensler said. He noted that brokers are banned from paying for order flow in the U.K., Canada and Australia.
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