The SEC recently agreed to “stay” part of its Transaction Fee Pilot (TFP) in response to a request of the incumbent exchange operators — NYSE, Nasdaq, and Cboe — which have been fighting this initiative since an SEC advisory committee recommended a fee pilot several years ago. The TFP, which will test the elimination of rebate payments used by exchanges to attract certain orders, grows out of longstanding and widespread dissatisfaction by institutional investors and many brokers. Investors are opposed to rebates because they create conflicts of interest with their brokers — rebate payments are typically not passed back and often result in inferior execution for the investors. So, after years of deliberation, the SEC finally approved the TFP by a unanimous, bipartisan vote. The exchanges promptly sued the SEC in federal court as a last-ditch attempt to squash the TFP, arguing that it represents a case of government overreach, and they asked the SEC to hit pause on the pilot while the lawsuit was pending.The SEC recently agreed to “stay” part of its Transaction Fee Pilot (TFP) in response to a request of the incumbent exchange operators — NYSE, Nasdaq, and Cboe — which have been fighting this initiative since an SEC advisory committee recommended a fee pilot several years ago. The TFP, which will test the elimination of rebate payments used by exchanges to attract certain orders, grows out of longstanding and widespread dissatisfaction by institutional investors and many brokers. Investors are opposed to rebates because they create conflicts of interest with their brokers — rebate payments are typically not passed back and often result in inferior execution for the investors. So, after years of deliberation, the SEC finally approved the TFP by a unanimous, bipartisan vote. The exchanges promptly sued the SEC in federal court as a last-ditch attempt to squash the TFP, arguing that it represents a case of government overreach, and they asked the SEC to hit pause on the pilot while the lawsuit was pending.
The grant of a partial stay by the SEC led to some initial press reports of a “win for the exchanges” and some momentary sideline celebration. Based on my personal experience in and out of government and an understanding of the facts, it seems clear, however, that this procedural step is highly unlikely to derail or delay the TFP and was instead a smart and proactive move by the SEC to keep things moving forward. The exchanges’ real hope lies in convincing the court to throw out the TFP, but given the weakness of their arguments, there is not much reason to think they will fare any better in court than they have in front of the SEC.The grant of a partial stay by the SEC led to some initial press reports of a “win for the exchanges” and some momentary sideline celebration. Based on my personal experience in and out of government and an understanding of the facts, it seems clear, however, that this procedural step is highly unlikely to derail or delay the TFP and was instead a smart and proactive move by the SEC to keep things moving forward. The exchanges’ real hope lies in convincing the court to throw out the TFP, but given the weakness of their arguments, there is not much reason to think they will fare any better in court than they have in front of the SEC.
A Smart Procedural Step
The SEC partial stay was smart because they did not pause a six-month data gathering phase, which is required by the TFP to be completed before the rebate restrictions kick in, to allow analysis of how markets for test stocks change in response to the pilot. If the SEC provides notice in May that the data gathering will begin in June, for instance, the rebate ban for test stocks could start in December, assuming the court has reached a decision rejecting the exchange’s challenge by that time. If not, the pilot could still proceed following a later decision that is favorable to the SEC, but the Commission would have to decide how to address any gap between the data gathering period and the onset of the pilot restrictions.The SEC partial stay was smart because they did not pause a six-month data gathering phase, which is required by the TFP to be completed before the rebate restrictions kick in, to allow analysis of how markets for test stocks change in response to the pilot. If the SEC provides notice in May that the data gathering will begin in June, for instance, the rebate ban for test stocks could start in December, assuming the court has reached a decision rejecting the exchange’s challenge by that time. If not, the pilot could still proceed following a later decision that is favorable to the SEC, but the Commission would have to decide how to address any gap between the data gathering period and the onset of the pilot restrictions.
So, any risk of meaningful delay remains in the hands of the court, and nothing the SEC did changes that, other than to make it less likely that the court might be tempted to issue its own delay while it sorts out the issues. In effect, the SEC is assuming that the court can sufficiently evaluate the exchanges’ arguments while the data collection is ongoing or shortly after it is completed. There are plenty of reasons to think that is a good assumption, because there are many reasons why the exchanges’ arguments, under the circumstances, are so weak. In fact, those arguments are essentially recycled versions of claims they have been repeating for the last several years, so far to no avail.So, any risk of meaningful delay remains in the hands of the court, and nothing the SEC did changes that, other than to make it less likely that the court might be tempted to issue its own delay while it sorts out the issues. In effect, the SEC is assuming that the court can sufficiently evaluate the exchanges’ arguments while the data collection is ongoing or shortly after it is completed. There are plenty of reasons to think that is a good assumption, because there are many reasons why the exchanges’ arguments, under the circumstances, are so weak. In fact, those arguments are essentially recycled versions of claims they have been repeating for the last several years, so far to no avail.
Why the Exchanges’ Legal Challenge is Baseless
First, contrary to their allegation that the SEC has acted precipitously, the SEC’s pace in considering this action has been deliberate, to put it mildly. The SEC raised concerns with the maker-taker structure in a think piece it issued in 2010, and it was a main focus of its Equity Market Structure Advisory Committee beginning in 2015. After the EMSAC recommended a fee pilot in 2016, the SEC put out a proposal two years later, and adopted the TFP after receiving and addressing in detail well over 100 written comment letters and after untold hours of discussions with stakeholders on every side.First, contrary to their allegation that the SEC has acted precipitously, the SEC’s pace in considering this action has been deliberate, to put it mildly. The SEC raised concerns with the maker-taker structure in a think piece it issued in 2010, and it was a main focus of its Equity Market Structure Advisory Committee beginning in 2015. After the EMSAC recommended a fee pilot in 2016, the SEC put out a proposal two years later, and adopted the TFP after receiving and addressing in detail well over 100 written comment letters and after untold hours of discussions with stakeholders on every side.
Second, there is zero basis for the exchanges’ claim that the SEC hasn’t carefully considered potential economic costs and benefits. The public record, including the SEC’s proposing and adopting release, is full of excruciating detail about the concerns that have been raised with the maker-taker system, what data is available and what is not, how it evaluated costs and benefits, and how it considered each concern raised by the exchanges and other market participants. The Commission also explained why it did not accept the recommendation of some commenters to ban rebates outright in preference to a pilot program. The fact the Commission didn’t buy the exchanges’ arguments does not mean it didn’t consider them. Companies subject to government rules have a right to a fair hearing. They don’t have a right to get their way because a particular rule stands to hurt their profits.Second, there is zero basis for the exchanges’ claim that the SEC hasn’t carefully considered potential economic costs and benefits. The public record, including the SEC’s proposing and adopting release, is full of excruciating detail about the concerns that have been raised with the maker-taker system, what data is available and what is not, how it evaluated costs and benefits, and how it considered each concern raised by the exchanges and other market participants. The Commission also explained why it did not accept the recommendation of some commenters to ban rebates outright in preference to a pilot program. The fact the Commission didn’t buy the exchanges’ arguments does not mean it didn’t consider them. Companies subject to government rules have a right to a fair hearing. They don’t have a right to get their way because a particular rule stands to hurt their profits.
Third, the rule in question here is a pilot. The SEC can’t ban rebates unless it takes further action, after considering the results of the test, and after providing more opportunity for comment. To try to preempt that obvious point, the exchanges argue they will be irreparably harmed if they are prevented from using rebates even for just some stocks for a limited a period of time — i.e. the genie will never go back in the bottle. On its face, the premise rings hollow. If the pilot leads to a general ban on rebates for some or all stocks, exchanges and everyone else will need to adapt. If not, arguing that the exchanges’ business will never recover betrays an astonishing lack of confidence in the resilience of that business.Third, the rule in question here is a pilot. The SEC can’t ban rebates unless it takes further action, after considering the results of the test, and after providing more opportunity for comment. To try to preempt that obvious point, the exchanges argue they will be irreparably harmed if they are prevented from using rebates even for just some stocks for a limited a period of time — i.e. the genie will never go back in the bottle. On its face, the premise rings hollow. If the pilot leads to a general ban on rebates for some or all stocks, exchanges and everyone else will need to adapt. If not, arguing that the exchanges’ business will never recover betrays an astonishing lack of confidence in the resilience of that business.
Finally, the overwhelming support of the pilot by the institutional investor community itself supports the rule more than any other data point could. Everyone involved in the debate has a stake in the outcome, but these many asset managers, pension funds, and other institutions have no stake except the desire for a well-functioning, efficient market for the millions of Main Street investors they represent. They have spoken clearly, and no one else is qualified to speak for them. At IEX, however, we plan to support their interests by filing our own brief with the court, as the only U.S. exchange that does not pay rebates.Finally, the overwhelming support of the pilot by the institutional investor community itself supports the rule more than any other data point could. Everyone involved in the debate has a stake in the outcome, but these many asset managers, pension funds, and other institutions have no stake except the desire for a well-functioning, efficient market for the millions of Main Street investors they represent. They have spoken clearly, and no one else is qualified to speak for them. At IEX, however, we plan to support their interests by filing our own brief with the court, as the only U.S. exchange that does not pay rebates.
Prepare for Takeoff
When the NYSE says, as they did in a recent opinion piece, that they are suing their regulator to protect the market, it should be clear to everyone it is their market, not the U.S. market, they are concerned about. There is simply no basis or precedent for a federal court overturning a regulatory action in circumstances like this. The old-line exchanges have every legal right to file this challenge, but no good reason to think it will be successful in holding back the tide that has turned against them.When the NYSE says, as they did in a recent opinion piece, that they are suing their regulator to protect the market, it should be clear to everyone it is their market, not the U.S. market, they are concerned about. There is simply no basis or precedent for a federal court overturning a regulatory action in circumstances like this. The old-line exchanges have every legal right to file this challenge, but no good reason to think it will be successful in holding back the tide that has turned against them.
Chief Market Policy Officer