May 27, 2015

Trading Through

Memorial Day is a time for reflection.

We marked it by viewing American Sniper, introspective cinema on prolonged war.  There comes a point along that continuum where people begin to feel helpless, caught by something they can neither fix nor change.

That of course got me thinking about the first Equity Market Structure Advisory Committee meeting, convened May 13 without anyone from the issuer community on hand.  Chair Mary Jo White tasked the team with weighing Rule 611.

Fight the eye-glaze urge that overwhelms at mere sight of the name. If you’re a participant in the equity market as all public companies are, you need to know how the market for traded shares works.

Rule 611 is one of four key tenets of Regulation National Market System, the regime behind our current terrific marketplace, and says trades cannot occur at prices worse than those displayed at another market in the national system. We say Order Protection Rule or Trade Through Rule because it prohibits “trading through” a better price.

The thinking was if brokers were jobbing clients with inferior prices, how do you stop it? The old-fashioned way of doing that is how you buy a car. You do some comparison-shopping, and enterprising folks create apps like TrueCar (which is what ECNs were!).

Perhaps concluding that humans buying and selling stocks are just too busy to take responsibility for getting a good deal themselves, the SEC decreed that all orders capable of setting market prices must be automated and displayed by exchanges. As the memo’s authors write, “If a broker-dealer routes an order to a trading venue that cannot execute the order at the best price, the venue cannot simply execute the order at an inferior price.”

This is why algorithmic and high-frequency trading exploded. But the SEC deserves credit here. In an unusually blunt and rather readable treatise prepared for Committee members, the SEC admits its rules “significantly affect equity market structure.”

What the SEC really wanted through Rule 611 was more limit orders, or stock-trades at defined prices instead of whatever one is best at the moment. “The SEC believed,” the memo says, “that greater use of displayed limit orders would improve the price discovery process and contribute to increased liquidity and depth.”

The opposite happened, and the SEC is again forthright, saying “limit orders interact with a much smaller percentage of volume today than they did prior to Rule 611. This development may suggest that Rule 611 has not achieved the objective…”

Supporting that conclusion, earlier this year Fidelity and fellow investing giants said they will launch a marketplace for stocks called Luminex Trading & Analytics. Other members are Blackrock, Bank of New York Mellon, Capital Group, Invesco Ltd., JPMorgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price Group Inc. The cadre manages assets topping $15 trillion.

These are your owners. The stock market isn’t working for them. The SEC is talking about it – even admitting errors. All the major exchanges in the past year – NYSE, Nasdaq, BATS Global Markets – have proposed big changes.  IEX, famed from Flash Boys, is working to create a radically different exchange model.

Yet 90% of CEOs and CFOs at great American public companies don’t know investors are unsatisfied or that everyone else in the equity market is talking about fixes. That’s not because they can’t grasp it. They don’t know because IR isn’t explaining it.  You can’t expect exchanges to do it. They serve multiple constituencies and we’re the least economically meaningful, to be frank.

This can be the Golden Age of IR if we seize the opportunity to command a role in market-evolution. IR sells products – shares of your stock. If they were widgets, we’d know every intimate detail about the widget market (executives would expect nothing less).

So why not the stock market? (Hint: We can help you drive this organizational change!)

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