Feb. 5, 2023
Dear Chairperson Gensler, Below please find my comments around your proposed rules 29-22, 30-22, 31-22 and 32-22 - heree-after collectively referred to as the wholesaler destruction over-reach proposals (WDOPs). By way of back ground, I am a long time follower, and commentator on a variety of Global Market Structure initiatives, across all manner of asset classes. I lean towards the left side of the political spectrum, and have some sympathy for the argument that the bilateral removal of benign retail flows from the markets at large may well be causing some harm to other retail investors, via inflated trading costs in institutional holdings (ETPs, Mutual Funds, Pension Plans). Having stated some sympathy for the underlying genesis of the various proposals, i must say that i am not in the least impressed with this iteration of the SEC, or the manner in which this series of proposals has come to pass. Firstly, the SEC - and most notably the Chair - have allowed, perhaps even inspired, a perverse narrative around U.S. equity markets being a crime scene, that is epically flawed. This narrative is detrimental to the overall confidence that investors, and most notably younger investors, have in our capital markets. The narratives, often found on twitter, or Reddit (and amusingly in the comments to your own twitter posts), suggest that the market is rigged via massive naked shorting, firms selectively deciding when assets are allowed to be bought, infinite synthetic share creation by market makers, and other crimes aimed at mistreating retail investors. Yet this SEC has done little, to nothing, to combat these troubling narratives. Indeed, Mr. Chair, you recently posted a video on Twitter, that seemed to strongly suggest the SEC’s proposed Best Ex rule would finally give the SEC an ability to enforce standards on brokers - which is of course ludicrous given the long time existence of a FINRA Best Ex rule. This self aggrandizing post empowers those pushing false narratives about our markets, and completely destroys any personal credibility you may cling too. Instead of publishing endless overlapping rules, with limited clarity around the nature of the problem they aim to solve, the definition of success or failure, or how said rules will interact with one another, the SEC should either provide data that either counters, or even supports these narratives. And if you support them, then propose rules to combat these marketplace shortcomings. Instead, over the past 24 months you have proposed rule, after rule, after rule - with little to no input from the street. You love to say the words “the SEC values your input”, but your actions tell us this isn’t true. You have shortened comment periods dramatically - despite increasing the number and complexity of proposals. When your term started, the SEC removed indices from the front of all rule proposals - something the republican commissioners were able to get back - a change that makes it significantly more difficult to consume and comment on proposals. You have greatly reduced interaction with industry. By way of example, the Clayton / Redfearn proposal to reduce exchange access fees contained 63 memorandum detailing meetings with industry on that topic - most before the proposals were published. Your 4 WDOP proposals have 16 such memorandum combined. No meetings with SIFMA, FIA or STA???? Why are you afraid to discuss proposals with industry experts, who most certainly understand both the issues and the workflow challenges, far better than you? Perhaps we should look at a few of the flaws that each of the proposals contains, before ending with some final comments on how the proposals work together. Best Ex The Best Ex proposal is interesting, in that it is almost completely redundant (ie FINRA has this, and also has desk audits that allow them to enforce the rule). Having two Best Ex rules, which will most certainly diverge over time, will lead dealers to parse overlapping or perhaps contradictory rule sets. What is the upside in having a second best ex rule. If the existing rule isn’t working, highlight what it is not capturing, and allow FINRA to update their rules, should they agree with your view. The main new feature of the Best Ex rule is wording that suggests, but doesn’t state clearly, retail firms will be required to attempt to get mid point execution for orders, before routing to a bilateral wholesale market maker. If this is what you require, why not state it outright? The suggestion is based on data, via the CAT system, showing wholesalers are able to get mid point executions on better than 50% of the volume they send to such venues. But the document doesn’t highlight which venues these are - competitive market places, single dealer platforms, central risk books - and fails to investigate what intelligence the wholesalers use to make such routing decisions. Are they using heat mapping, or reacting to IOIs? Without further clarity, it is impossible to consider what the likely outcome will be for retail investors. I think all informed participants realize that if such mid point venues capture even a fraction of the 50% number, the wholesalers will be left with considerable less attractive flow, severely harming or even killing this business. Given the likely impact of such a rule change, it is imperative that the SEC provide far better data analysis on which to base proposals. As stated earlier in my letter, i am sympathetic to the debate that siphoning retail flow away from the rest of the market may not be positive, but we need to have real analytics behind any reversal as impactful as the one proposed. The rule also seems to suggest that retail firms need to send option orders in a manner that is open to competition - which is correct, It is also counter to comments you made at a broker conference last June, when you laughably suggested the equities markets should emulate US option markets. What changed? The US options markets are as non competitive as any on the planet - but you have held them up as a bastion of price discover and competition. What up with that? Given the comments you have made, and your current role, i think you owe both industry and investors some clarity around your views. Order Competition The auction proposal makes little to no sense. If we force retail to route via reasonable midpoint pools, the remaining orders are not going to be attractive to contra side auction participants. Who wants to competitively bid for picked over flow? The toxicity will be less that ideal, and the 100 - 300 Millisecond delay is a tax on retail investors unlikely to get improved fill quality. The data analysis behind the 100 - 300 millisecond delay is tragically bad. comparing the opportunity for quote fade on printed trades versus firm order intents (even at retail size) is anything but an apples to apples comparison. That analysis is completely useless. And why are small retail orders, from occasional traders / investors subject to a different best ex requirement than larger orders, or orders from regular traders. Can dealers really chose to give better execution to participants based on how often they trade? This line of reasoning is completely head scratching. Tick Size Most of the industry has been suggesting a change in tick size for some time. But your proposal is concerning. There are a few score of names that should have ticks as small as 1/10th or 2/10s of a penny. Your proposal will lead to over 1000 names having ticks this small, the proposal has zero analysis around the increased costs associated with an almost certain surge in message traffic. And contains zero consideration around what the likely impacts will be on quoted liquidity. In March of 2020, when market depth collapsed, we saw a massive increase in usage of peg offset dark orders at both Nasdaq and BATS, Such orders allow traders to post 1 (or more) ticks ahead of the NBBO, in the dark. A move to 1/10th of a penny tick, will almost certainly drive masses of flow to such order types, reducing the visible liquidity the market dearly needs to inform efficient price discovery. The pilot also changes the nature of exchange tiers, but does so in a confusing way. Lots of folks hate tiers - they are massively anti competitive. But instead of banning them, you are forcing exchanges to use a look back on past flow, to set fees - which is even more anti competitive, as smaller brokers can’t attract new flows based on modelling of what such flows will do to their rates upon arrival. At its heart, the tick proposal might be digestible, if not for the fact it is being proposed alongside changes to retail routing best ex obligations and the introduction of retail auction systems. The overall complexity of the proposals is beyond the scope of any market structure expert to truly envisage. The real harm being done, is the related proposals are so overlapping and complex, as to make success near impossible. There is some reason to consider changes to tick size, bilateral order routing and fee tiers. But when these Venn Diagram monstrosity of a set of proposals ultimately fails, such debates will be set back generations. The first goal of any regulator should be to do no harm. these proposals fail miserable in this regard. For that reasons, and literally dozens more I could spend days articulating, I am against the rules as proposed, and hope the SEC stands down, honestly engages in industry, and puts forward more sober proposals in the future. Your Friend Daniel Matthew Mulson Jr. (He/Him) Market Structure Student and Occasional Commentator