Fairer and More Competitive Public Markets

Last December, the Commission proposed significant reforms to enhance transparency and increase competition in our equities markets.

Today, the Commission proposes an additional market structure reform to increase transparency in the complex and opaque system of tiered transaction pricing currently used by many exchanges.

In 2004, the Commission adopted a rule capping the fees that exchanges are allowed to charge their members for executing stock trades. The purpose of this fee limit was to ensure the fairness and accuracy of displayed prices on exchanges and to do what is required by law: provide for the equitable allocation of fees, prevent unfair discrimination “between customers, issuers, brokers, or dealers,” and avoid the imposition of any unnecessary or inappropriate burden on competition.

The general market practice that evolved under this rule, and that successive Commissions signed off on, was the setting of access fees at or near the cap. Exchanges, in turn, offered rebates to their customers to increase their market share.

An unintended consequence of this practice is a flawed pricing structure that is neither transparent nor competitive.

Many exchanges use complex pricing schedules, or tiers, that offer lower fees or higher rebates based on how much a member trades on that exchange. However, exchanges are currently not required to disclose the number of members that qualify for any particular tier, including the tiers that offer the lowest fees or largest rebates.

As a result of this complexity and lack of transparency, both market participants and regulators lack key data that would help them assess the fees charged and rebates paid to different exchange members, or the competitive burdens of an exchange’s pricing proposals.

Volume-based pricing also creates competitive disparities among exchange members, primarily broker-dealers. A broker-dealer with higher trading volume on an exchange may qualify for better pricing or higher rebates than a lower volume competitor, regardless of the firm’s size.

These lower volume firms might find it more difficult to compete for customer orders because the current pricing structure prevents them from offering the lowest fees or largest rebates to their customers. In some cases, these firms may have an economic incentive to route customer orders through a higher volume firm so as to obtain better pricing.

Today’s proposal would increase transparency around fees and rebates for proprietary trading by requiring exchanges to disclose, via EDGAR, their pricing tiers and the number of members in each tier. This information would bring transparency to the market and would also inform the Commission’s decision-making when considering whether a proposed fee filing meets the standards required by law.

By prohibiting exchanges from using volume-based pricing for customer order flow, today’s reforms may also increase competition among broker-dealers. And while volume-based discounts may be a common feature in the broader world of commerce, current practices under existing exchange rules lack transparency, are anti-competitive, and run counter to the equitable allocation of fees and the prevention of unfair discrimination required by law.

In addition to leveling the playing field, the prohibition addresses an inherent conflict of interest that exists when a broker-dealer has an incentive to route a customer order to a particular exchange for the broker-dealer’s own benefit, at the expense of its customer.

Today’s reforms will address some of these inherent conflicts of interest, bring transparency to the current pricing structure, and promote competition.

Thanks to Commission staff for their hard work on this proposal. I would also like to thank Commissioner Crenshaw for her leadership in crafting and advancing this important proposal, which I’m pleased to support.