On May 22, fees charged by the SEC on trading rose 248%.
It’s not widely understood that the fees from initial public offerings, follow-on and secondary offerings, proxy solicitations and corporate buybacks (under sections 6b, 13e and 14g of the Securities Acts) were directed away from the Securities and Exchange Commission to the Treasury by Dodd-Frank legislation after the 2008 financial crisis.
The SEC now is funded by a tariff. Congress appropriates funding and requires the SEC to offset its costs with trading fees under Section 31 of the Securities Acts. Until May 22, the fee was $8.00 per million dollars of trading volume.
I can’t tell you all the thinking that’s behind it because it originated in an inscrutable place: Congress. But while buybacks are big, leading to meaningful flows to the US Treasury General Fund – the government’s checking account –IPOs are way down. Have been for 25 years.
So Congress used the financial crisis to take money from the stock market and shift the burden for funding regulatory oversight to traders. Here’s the amusing part: Congress appropriates money for the SEC in the annual Further Appropriations Act.
First Congress passes an omnibus spending bill for some trillions of dollars annually that’s now running about $2 trillion more than we collect. Then it quietly passes yet more appropriations in a separate bill. Last year it was about $468 billion more. Look it up.
The 2024 bill included about $2.2 billion for the SEC. The commission projected it would collect less than $1 billion at the $8.00/$1mm rate and so ratcheted up the fee to fund the shortfall of about $1.3 billion.
Voila, it jumps to $27.80 per $1 million of trading volume.
It’s not a lot in a stock market trading $600 billion a day. But it’s a massive annual increase. And it impacted trading volumes at exchanges, which serve as collection agents. More transactions are matching at Alternative Trading Systems (dark pools). In September thus far we’re close to a 50/50 split – half the volume at exchanges, half at dark pools.
That’s a 20% swing. Traders are avoiding higher costs.
Dark pools aren’t bad. But suppose you had to buy half your groceries at farmers’ markets instead of the grocery store (not that I’m suggesting dark pools are hayseeds).
What’s more, if volume in dark pools grows, we see fewer prices, fewer quotes. Plus, Fast Traders who want only to take a fraction of a cent make more money. They race ahead of trades – half of which nobody sees.
Guess who’s on pace to produce record profits, according to trade-publication reporting? Citadel, Jane Street, two major high-speed firms.
Fast Traders like Citadel are in effect extracting a tariff too, because the SEC exempts bona fide market-making – setting the bid and offer – from short-locate rules. Right now, literally more volume is short than long: 51%.
What’s more, Fast Traders “cross the spread” between the bid to buy and offer to sell to match trades. Fast Traders buy all the proprietary data feeds and place orders faster than everyone else. They’re half the trading volume. When half the volume is hidden, their comparative advantage grows.
Is that inflationary? Maybe. But more inflationary is Passive investment that follows those prices.
Why? Stock-pickers over the long run, the data show, don’t like to pay more than 16 times earnings. But Passive funds don’t value stocks. They deploy flows. And they’re getting them all. Actives are net sellers, while Passives are taking more than $500 billion annually from them. They’re 70% of assets now.
Add it up. Higher fees. Fast Traders profiting on market-making exemptions and faster data and dark/light arbitrage. Passives paying whatever price is asked.
Risky? Passive money has never yet had net outflows. Not during the 2008 financial crisis. There were just $400 billion of assets in ETFs then. Now, there are $9 trillion in ETFs in the US alone. If ever that money hits the exits…well, we’ll know.
Compare to economic tariffs. The Constitution under Article I Section 10 permits states to cover inspection costs for imports and exports with tariffs, and net proceeds are to go to the US Treasury. In effect, the US government was meant to fund itself by taxing foreign access to our market.
But it got so big it had to loot its citizens.
We’re the largest economy in the world. Yet the US imposes no taxes on foreign investment. I’d be all for a Section 31 fee on foreign access to our massive market.
And if you want to know what effect Fast Trading has on your stock price, public companies, we can tell you. Same with Passive money. And investors? The ecosystem determines the outcome. You must understand it. We can help.
