SEC Investor Advisory Committee meeting
Securities and Exchange Commission
Investor Advisory Committee
Meeting
Thursday,
October 15, 2015
Key
Topics & Takeaways
- Maker-Taker
Fee Assessment: Gary Goldsholle, Deputy Director of
the Securities and Exchange Commission’s (SEC’s) Division of Trading and
Markets, explained
that the Equity Market Structure Committee is currently examining
maker-taker fees, which he said will be discussed at the Committee’s next meeting on October 27th.
- Block
Trade Exemptions: Eric Noll, President and Chief
Executive Officer of Convergex Group, recommended a block trade exemption
from Reg. NMS, stating that the average trade size has decreased which
increases fragmentation and ultimately may not result in best execution
for clients. He argued that it
would be “useful” to examine best execution in relation to the parent
order, i.e. by considering whether each small orders cumulatively made the
market move away and result in trading at an inferior price.
- Re-Calibrating
Limit Up Limit Down (LULD): Several market
practitioners called for changes to the pilot Limit Up Limit Down
mechanism in light of the August 24th market dislocations. Chris Concannon, CEO of BATS, claimed
that while the LULD worked “perfectly as designed, [. . .] the design had
flaws.”
- Strengthening Enforcement: Andrew
Ceresney, Director of the SEC’s Enforcement Division, expressed support
for two Senate bills that would strengthen enforcement of civil penalties
and extend the
statute of limitations for certain SEC actions. Ceresney said he is supportive of both
pieces of legislation, noting that changing the statutes of limitations
would be the “easier one.”
Speakers
- Mary Jo White, SEC Chair
-
Kara Stein, SEC Commissioner
-
Giles Cohen (on behalf of Commissioner Aguilar), General Counsel
-
Gary Goldsholle, Deputy Director, Division of Trading and Markets
-
Eric Noll, President and Chief Executive Officer, Convergex Group
-
Samara Cohen, Managing Director – Head of US iShares Capital
Markets, BlackRock
-
Chris Concannon, Chief Executive Officer, BATS
-
Brendon Weiss, Co-Head, Government Affairs, InterContinental
Exchange (ICE)
-
Andrew
Ceresney,
Director of the SEC’s Enforcement Division
-
Donald
Langevoort,
Professor at Georgetown Law School
-
Introduction
Opening remarks by Chair White
Chair White opened
by noting the progress that the Securities and Exchange Commission (SEC) has
made in rulemaking on executive compensation issues, new rules for
security-based swaps, and rules governing asset managers (such as data
collection/modernization and liquidity risk management proposals). White also shared that the SEC is continuing
its analysis on exchange-traded products (ETPs), particularly in light of the
volatility and market disruptions experienced on August 24, 2015. She also noted that the Limit Up Limit Down
(LULD) mechanism, which is currently running on a pilot basis, provides the
Commission with a significant amount of trading data to examine and better
understand the drivers of price dislocations in ETPs.
Opening remarks by Commissioner Stein
Commissioner Stein opened
by encouraging the Investor Advisory Committee to examine whether the current
market structure continues to serve investors, and expressed particular
interest in their recommendations on which market structure issues the SEC
should prioritize going forward. Stein
also mentioned that August 24th provided insight into how LULD
worked in a stressed environment and welcomed the Committee’s views on whether
changes were necessary to the LULD mechanism to protect investors.
Opening remarks by Giles Cohen on behalf of Commissioner
Aguilar
Giles Cohen, General
Counsel to Commissioner Aguilar, delivered remarks on Commissioner Aguilar’s
behalf. He referenced the Commissioner’s
May 2015 remarks on market structure
issues, which he said the Commissioner stands by. He also expressed interest in the Committee’s
views on several issues, including whether: 1) there should be changes to the
price bands of ETPs; 2) market wide circuit breakers should be recalibrated; 3)
LULD price bands should be harmonized; and 4) the New York Stock Exchange
(NYSE) should publish its order imbalances even when closed to trading.
Approval of Minutes of Previous Meeting
The Investor Advisory
Committee approved the minutes from the July 16th meeting by a voice vote.
Discussion of Recent Market Structure Developments
Gary
Goldsholle, Deputy Director, Division of Trading and Markets
Gary Goldsholle explained
that the SEC’s recently launched Equity Market Structure Committee held its
first meeting in May. He summarized
several ongoing priorities for the Committee, including Rule 611 of Regulation
NMS, known as the “trade through rule,” which he claimed has many benefits
including promoting competition and market confidence. However, he noted the Committee
is examining the unintended consequences it has on market complexity,
fragmentation, and increased operational costs (including trading center
fees). Goldsholle explained that the
Committee is currently examining maker-taker fees, which he said will be
discussed at the Committee’s next meeting on October 27th.
Regarding the Tick Size Pilot,
Goldsholle explained that the November 6th date for reporting data
is rapidly approaching, and the Committee is frequently discussing how to move
forward with the pilot while addressing industry concerns. He assured the Investor Advisory Committee
that the data collection exercise will enable the SEC to conduct a robust
analysis on the pilot’s impact on retail investors.
Goldsholle also mentioned
that the Equity Market Structure Committee is examining market resilience in
light of the July 8th market disruption event (in addition to the
market disruptions on August 24th), particularly with respect to the
opening and closing mechanisms. He also
noted that Professor James Angel recently recommended several changes to LULD,
including changing the reference price for ETPs, in cases where there is no
opening auction, to be based on the last day’s closing price (rather than the
mid-point between the bid-ask spread); and recalibrating the trading bands and
the double bands used at the open and close of the market; among other themes. Goldsholle
also explained that the SEC is analyzing data on manual and automated opening
mechanisms work, and he noted the exchanges are also conducting their own
self-assessments.
Goldsholle also mentioned
the Committee is undertaking work to: 1) enhance transparency of alternative
trading systems; 2) implement Rule 606 regarding order routing disclosures to
institutional and retail investors; and 3) examine data to determine what, if
anything, the SEC should do regarding anti-disruptive trading.
Eric Noll, President and CEO of Convergex Group
Noll opened by stating that most buy
side investors prefer markets to be open to facilitate price discovery, even if
it is “flawed,” and argued that markets should be open as close to 9:30 am as
possible to avoid dislocations. Regarding LULD, Noll claimed that trading halts
do not provide the stability they should, and noted that when stocks re-opened
via auction on August 24th, after a trading halt, market makers
often did not participate in the re-opening auction, which was problematic and
perpetuated the cycle. He also claimed that net asset value (NAV) pricing in
ETPs is “unreliable.”
Noll maintained that the Tick Size Pilot
has the “potential to show dynamics around putting provisions for small and
mid-sized stocks.” While he recognized
the industry’s concerns regarding building systems for securities that exhibit
low trading volumes and have low economic value, he said he believes that
ultimately there will be value in discovering hidden liquidity in small and
mid-sized securities. He also cautioned that liquidity will likely get worse
once the Tick Size Pilot is launched, but encouraged market participants to see
how it works over time and examine success metrics other than bid-ask spreads,
to determine whether the pilot is truly successful.
Noll claimed that order routing is
often dictated by maker-taker fees and explained that there is “always
conflict” between duty to one’s client and the economics of trading. He encouraged the Committee to examine whether
conflicts are adequately disclosed and whether liquidity provision always needs
to be incented. Noll closed by stating
that as the industry addresses maker-taker, it needs to “think very carefully
about incentives to provide liquidity” to create efficient markets.
Noll also
recommended a block trade exemption from Reg. NMS, stating that the average
trade size has decreased
which increases fragmentation and ultimately may not result in best execution
for clients. He argued that it would be
“useful” to examine best execution in relation to the parent order, i.e. by considering
whether each small orders cumulatively made the market move away and result in
trading at an inferior price.
Noll argued that the most critical
issue for the buy-side on August 24th was concern that the closing
mechanism would not be operational, which is crucial to valuation
practices. He argued that there “has not
been an adequate answer” to those concerns.
Noll noted that his firm operates
two alternative trading systems (ATS) or dark pools, which he claimed offer
“real value” in terms of market liquidity.
He argued that transparency could be improved in certain aspects of ATS
or dark pools, such as their operating/trading rules, market data, and order
types allowed, among other things.
Question & Answer
When asked what was the “most
concerning” market structure issue, Goldsholle explained that he believed it
was “how interconnected everything is,” meaning that one market structure
impediment in isolation will not resolve the issues affecting modern markets. Noll
agreed, explaining that there is no fatal flaw but rather current market
structure concerns are a “much more complex problem” which require “a more
nuanced and complete approach.”
In response to a question regarding
the impact of increased liquidity risk on investors, Noll explained that
liquidity is concentrated in the top 100 or so stocks, and that while not new,
the recent increases in market liquidity are “more extreme.”
When asked whether high-frequency
trading (HFT) played a role in current market structure challenges, Noll
cautioned that there are definitional problems of what does, or does not,
constitute HFT, and explained that it is more important to examine behaviors to
determine whether manipulative trading behaviors are taking place. Goldsholle clarified that HFT will be “front
and center” for the Equity Market Structure Committee’s ongoing discussion on
maker-taker fees, which he said is intrinsically linked to HFT.
Discussion of ETF Pricing
Concannon opened by stating that
BATS is one of the largest exchange operators for ETFs, and hosts over 40
percent of on-exchange ETF trading. Concannon
claimed that, on August 24th, “ETFs were not the problem,” rather he
argued that the “markets failed ETFs.” Concannon also noted that despite a
“wall of message traffic” and the “enormous” volume of trading flows that day,
there were no technical glitches. He
argued that while the LULD worked “perfectly as designed,
[. . .] the design had flaws.” For
instance, he recalled that some trading halts were implemented once the
security price was recovering from a fall, however the LULD mechanism was
restraining the price from coming back up to its natural level.
Concannon put forth three
recommendations based on his observations of August 24th: 1) opening
primary markets near 9:30 am whether manual or automated; 2) re-evaluating
LULD, as well as how halted stocks are re-opened; and 3) extending the limit
state period (which is usually limited to 15 seconds) rather than halting
trading.
Samara Cohen, Managing Director – Head of US iShares Capital
Markets, BlackRock, noted that many things worked well on August
24th, despite significant problems during market opening. She claimed that the use of market and stop
loss orders exacerbated selling pressure and contributed to pricing
dislocations. Cohen highlighted several
recommendations from BlackRock’s recent whitepaper to improve ETP pricing in the
future, including: 1) harmonizing trading rules across the ecosystem; 2)
educating investors about how to navigate the modern U.S. equity market; and 3)
making changes to market microstructure, such as recalibrating LULD,
standardizing price bands throughout the day, and considering whether to invoke
market-wide circuit breakers during market-wide stress events.
Brendon Weiss, Co-Head, Government Affairs,
InterContinental Exchange (ICE), explained that NYSE Arca lists approximately
85 percent of ETPs, and noted different structures used by NYSE and Arca,
principally that NYSE runs a traditional model with human interventions while
Arca is a fully automated system. He
explained that the NYSE Group believes strongly that delaying market opening is
important during stress events to reduce volatility once the exchange is
open. Weiss noted that there are several
lessons learned during August 24th, and that LULD worked “as
designed” but exposed gaps on areas that can be improved significantly. Weiss called for better investor and issuer
education on how collars work, particularly during the opening mechanism. He also echoed calls for considering changes
to LULD, market wide circuit breakers, reference prices, and considering
whether double wide percentages are necessary near market open and close.
Weiss also mentioned that he is the
chair of the Tick Size Pilot and said it had “taken a while” for self-regulatory
organizations (SROs) to put out rules, FAQs, and data collection exercises. He also
noted that the FAQs were published last week and were developed with
considerable industry input and expressed the need for a six month time
extension.
Question and Answer
When asked why the price
dislocations experienced on August 24th were a U.S. market
phenomenon, Cohen explained that U.S.-listed ETFs that invest in U.S. assets
usually do not use valuation models that incorporate adjacent prices (from
futures markets, etc.). Concannon also
added that NAV is a “great guide” on market pricing, but since it is based on a
past day’s closing price, it is not a reliable price indicator in real
time.
In response to a question regarding
the drivers of volatility on August 24th, Concannon noted that the
U.S. marked opened down due to concerns about the Chinese market, as well as
other factors.
Market practitioners also discussed
the post-halt reopening process and whether it should be a differentiator
between competitors. Weiss called for
aggregating the auctions across trading venues to concentrate liquidity. Concannon agreed that different trading
venues should hold an identical re-opening auction after trading halts (at the
same time under the same rules), insisting that it should not be a competitive feature
of trading venues.
A committee member asked whether
LULD exacerbates problems, despite the fact that it was implemented to reduce
market volatility. Concannon claimed
that single stock LULD is “absolutely” necessary and explained that it works
“quite well” on most days. Cohen agreed,
adding that the number of LULDs on August 24th raises questions
about how it reacts during market-wide stress events, rather than in response
to idiosyncratic events. She called for
limiting actual halts, by extending the limit state to help market makers have
enough time to provide the necessary liquidity.
Weiss agreed and explained that the overarching message is that the market
“needs[s] to incentivize liquidity provision through rewards.”
FASB Materiality
Proposal
James Schnurr, SEC Chief Accountant,
noted that the Financial Accounting Standards Board proposed improvements to its disclosure
framework, specifically on “materiality.” He explained that the proposal is
currently out for public comment and thus he could not say whether he supports
the changes. However, Schnurr highlighted that the proposal is meant to be a
clarification and is not intended to change how preparers and auditors look at
materiality. He noted there has been disagreement around management’s ability
to determine if a disclosure is material and whether they have the ability to
omit immaterial information. He then explained the proposal states that if
management and an auditor agree that the disclosure is not material, then it
does not need to be treated as an error.
Silvers stated that changing the
broad terms of the definition of materiality could have a large impact and
reduce the overall amount of disclosure. He said that from the public’s
perspective, more disclosure is better than less and that this should give the
SEC’s accounting division impetus to intervene.
SEC Enforcement
Priorities
Andrew Ceresney,
Director of the SEC’s Enforcement Division, explained that the SEC’s mission is
to protect investors and noted that micro-cap fraud has been an area of focus.
He said the SEC has created a micro-cap task force comprising 30 full-time
attorneys that work with criminal authorities and focus on “key players” and
“gatekeepers.”
Ceresney also noted that the
Division of Enforcement has been working to address 1) pyramid schemes; 2) offering
frauds and Ponzi schemes; 3) large financial institution misconduct; 4) market
structure violations; 5) Reg SHO violations; and 6) misconduct in the sale of
complex financial instruments.
Donald Langevoort,
Professor at Georgetown Law School, said that securities laws are “woefully
unenforced” and misconduct “far exceeds” the reach of the SEC’s enforcement
division. He stressed that the Department of Justice (DoJ) and the SEC are
under-funded and that enforcement cases must be triaged as a result.
Question and Answer
Carcello asked if the Division of
Enforcement looks at the inspection reports of the Public Company Accounting
Oversight Board (PCAOB) and if enforcement actions are taken against audit
committee members. Ceresney said that a number of cases have been brought
against audit firms and audit committee members and said his division does
generally look at PCAOB reports.
Goettsch asked if Ceresney supports
the Stronger Enforcement of Civil Penalties Act (S.1730) put forth by Sen. Charles Grassley
(R-Iowa) and a bill to extend the statute of limitations for certain SEC
actions (S.1960) put forth by Sen. Jack Reed
(D-R.I.). Ceresney said he is supportive
of both pieces of legislation, noting that changing the statutes of limitations
would be the “easier one.” He added that the DoJ has a longer statute of
limitations than the SEC, but that the two “should be parallel.” Ceresney then
said that if SEC penalties affected investor losses more directly they would
have a bigger impact and pose a larger threat to deter misconduct.
Brown noted that administrative law
judges (ALJs) are not appointed by the head of the agency and that some courts
say this system is unconstitutional. He suggested that the SEC Chair could
appoint these judges or delegate the authority to do so, to avoid problems with
constitutionality. Ceresney explained that ALJs are employees, not officers,
and said he does not think the SEC has to solve a “constitutional problem,” because
he does not “see it as such.” He continued that administrative proceedings are
a “fair forum” and that Congress gave the SEC the authority to choose where
cases are heard. Ceresney added that the agency will do what they can to
advance their mission of protecting investors and said that while he has heard
many complaints about ALJs, he has not heard any complaints about them from
investors.
Wallman asked why bad actors are not
put in jail more often and expressed concern that while individuals are punished
at small firms, they are “insulated” from punishment at large firms. Ceresney
said that prison and action against individuals is the “greatest deterrent”
against misbehavior, adding “this is what we go for.”
More information about
this event can be accessed here.
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Securities and Exchange Commission
Investor Advisory Committee
Meeting
Thursday,
October 15, 2015
Key
Topics & Takeaways
- Maker-Taker
Fee Assessment: Gary Goldsholle, Deputy Director of
the Securities and Exchange Commission’s (SEC’s) Division of Trading and
Markets, explained
that the Equity Market Structure Committee is currently examining
maker-taker fees, which he said will be discussed at the Committee’s next meeting on October 27th. - Block
Trade Exemptions: Eric Noll, President and Chief
Executive Officer of Convergex Group, recommended a block trade exemption
from Reg. NMS, stating that the average trade size has decreased which
increases fragmentation and ultimately may not result in best execution
for clients. He argued that it
would be “useful” to examine best execution in relation to the parent
order, i.e. by considering whether each small orders cumulatively made the
market move away and result in trading at an inferior price. - Re-Calibrating
Limit Up Limit Down (LULD): Several market
practitioners called for changes to the pilot Limit Up Limit Down
mechanism in light of the August 24th market dislocations. Chris Concannon, CEO of BATS, claimed
that while the LULD worked “perfectly as designed, [. . .] the design had
flaws.” - Strengthening Enforcement: Andrew
Ceresney, Director of the SEC’s Enforcement Division, expressed support
for two Senate bills that would strengthen enforcement of civil penalties
and extend the
statute of limitations for certain SEC actions. Ceresney said he is supportive of both
pieces of legislation, noting that changing the statutes of limitations
would be the “easier one.”
Speakers
- Mary Jo White, SEC Chair
-
Kara Stein, SEC Commissioner
-
Giles Cohen (on behalf of Commissioner Aguilar), General Counsel
-
Gary Goldsholle, Deputy Director, Division of Trading and Markets
-
Eric Noll, President and Chief Executive Officer, Convergex Group
-
Samara Cohen, Managing Director – Head of US iShares Capital
Markets, BlackRock -
Chris Concannon, Chief Executive Officer, BATS
-
Brendon Weiss, Co-Head, Government Affairs, InterContinental
Exchange (ICE) -
Andrew
Ceresney,
Director of the SEC’s Enforcement Division -
Donald
Langevoort,
Professor at Georgetown Law School -
Introduction
Opening remarks by Chair White
Chair White opened
by noting the progress that the Securities and Exchange Commission (SEC) has
made in rulemaking on executive compensation issues, new rules for
security-based swaps, and rules governing asset managers (such as data
collection/modernization and liquidity risk management proposals). White also shared that the SEC is continuing
its analysis on exchange-traded products (ETPs), particularly in light of the
volatility and market disruptions experienced on August 24, 2015. She also noted that the Limit Up Limit Down
(LULD) mechanism, which is currently running on a pilot basis, provides the
Commission with a significant amount of trading data to examine and better
understand the drivers of price dislocations in ETPs.
Opening remarks by Commissioner Stein
Commissioner Stein opened
by encouraging the Investor Advisory Committee to examine whether the current
market structure continues to serve investors, and expressed particular
interest in their recommendations on which market structure issues the SEC
should prioritize going forward. Stein
also mentioned that August 24th provided insight into how LULD
worked in a stressed environment and welcomed the Committee’s views on whether
changes were necessary to the LULD mechanism to protect investors.
Opening remarks by Giles Cohen on behalf of Commissioner
Aguilar
Giles Cohen, General
Counsel to Commissioner Aguilar, delivered remarks on Commissioner Aguilar’s
behalf. He referenced the Commissioner’s
May 2015 remarks on market structure
issues, which he said the Commissioner stands by. He also expressed interest in the Committee’s
views on several issues, including whether: 1) there should be changes to the
price bands of ETPs; 2) market wide circuit breakers should be recalibrated; 3)
LULD price bands should be harmonized; and 4) the New York Stock Exchange
(NYSE) should publish its order imbalances even when closed to trading.
Approval of Minutes of Previous Meeting
The Investor Advisory
Committee approved the minutes from the July 16th meeting by a voice vote.
Discussion of Recent Market Structure Developments
Gary
Goldsholle, Deputy Director, Division of Trading and Markets
Gary Goldsholle explained
that the SEC’s recently launched Equity Market Structure Committee held its
first meeting in May. He summarized
several ongoing priorities for the Committee, including Rule 611 of Regulation
NMS, known as the “trade through rule,” which he claimed has many benefits
including promoting competition and market confidence. However, he noted the Committee
is examining the unintended consequences it has on market complexity,
fragmentation, and increased operational costs (including trading center
fees). Goldsholle explained that the
Committee is currently examining maker-taker fees, which he said will be
discussed at the Committee’s next meeting on October 27th.
Regarding the Tick Size Pilot,
Goldsholle explained that the November 6th date for reporting data
is rapidly approaching, and the Committee is frequently discussing how to move
forward with the pilot while addressing industry concerns. He assured the Investor Advisory Committee
that the data collection exercise will enable the SEC to conduct a robust
analysis on the pilot’s impact on retail investors.
Goldsholle also mentioned
that the Equity Market Structure Committee is examining market resilience in
light of the July 8th market disruption event (in addition to the
market disruptions on August 24th), particularly with respect to the
opening and closing mechanisms. He also
noted that Professor James Angel recently recommended several changes to LULD,
including changing the reference price for ETPs, in cases where there is no
opening auction, to be based on the last day’s closing price (rather than the
mid-point between the bid-ask spread); and recalibrating the trading bands and
the double bands used at the open and close of the market; among other themes. Goldsholle
also explained that the SEC is analyzing data on manual and automated opening
mechanisms work, and he noted the exchanges are also conducting their own
self-assessments.
Goldsholle also mentioned
the Committee is undertaking work to: 1) enhance transparency of alternative
trading systems; 2) implement Rule 606 regarding order routing disclosures to
institutional and retail investors; and 3) examine data to determine what, if
anything, the SEC should do regarding anti-disruptive trading.
Eric Noll, President and CEO of Convergex Group
Noll opened by stating that most buy
side investors prefer markets to be open to facilitate price discovery, even if
it is “flawed,” and argued that markets should be open as close to 9:30 am as
possible to avoid dislocations. Regarding LULD, Noll claimed that trading halts
do not provide the stability they should, and noted that when stocks re-opened
via auction on August 24th, after a trading halt, market makers
often did not participate in the re-opening auction, which was problematic and
perpetuated the cycle. He also claimed that net asset value (NAV) pricing in
ETPs is “unreliable.”
Noll maintained that the Tick Size Pilot
has the “potential to show dynamics around putting provisions for small and
mid-sized stocks.” While he recognized
the industry’s concerns regarding building systems for securities that exhibit
low trading volumes and have low economic value, he said he believes that
ultimately there will be value in discovering hidden liquidity in small and
mid-sized securities. He also cautioned that liquidity will likely get worse
once the Tick Size Pilot is launched, but encouraged market participants to see
how it works over time and examine success metrics other than bid-ask spreads,
to determine whether the pilot is truly successful.
Noll claimed that order routing is
often dictated by maker-taker fees and explained that there is “always
conflict” between duty to one’s client and the economics of trading. He encouraged the Committee to examine whether
conflicts are adequately disclosed and whether liquidity provision always needs
to be incented. Noll closed by stating
that as the industry addresses maker-taker, it needs to “think very carefully
about incentives to provide liquidity” to create efficient markets.
Noll also
recommended a block trade exemption from Reg. NMS, stating that the average
trade size has decreased
which increases fragmentation and ultimately may not result in best execution
for clients. He argued that it would be
“useful” to examine best execution in relation to the parent order, i.e. by considering
whether each small orders cumulatively made the market move away and result in
trading at an inferior price.
Noll argued that the most critical
issue for the buy-side on August 24th was concern that the closing
mechanism would not be operational, which is crucial to valuation
practices. He argued that there “has not
been an adequate answer” to those concerns.
Noll noted that his firm operates
two alternative trading systems (ATS) or dark pools, which he claimed offer
“real value” in terms of market liquidity.
He argued that transparency could be improved in certain aspects of ATS
or dark pools, such as their operating/trading rules, market data, and order
types allowed, among other things.
Question & Answer
When asked what was the “most
concerning” market structure issue, Goldsholle explained that he believed it
was “how interconnected everything is,” meaning that one market structure
impediment in isolation will not resolve the issues affecting modern markets. Noll
agreed, explaining that there is no fatal flaw but rather current market
structure concerns are a “much more complex problem” which require “a more
nuanced and complete approach.”
In response to a question regarding
the impact of increased liquidity risk on investors, Noll explained that
liquidity is concentrated in the top 100 or so stocks, and that while not new,
the recent increases in market liquidity are “more extreme.”
When asked whether high-frequency
trading (HFT) played a role in current market structure challenges, Noll
cautioned that there are definitional problems of what does, or does not,
constitute HFT, and explained that it is more important to examine behaviors to
determine whether manipulative trading behaviors are taking place. Goldsholle clarified that HFT will be “front
and center” for the Equity Market Structure Committee’s ongoing discussion on
maker-taker fees, which he said is intrinsically linked to HFT.
Discussion of ETF Pricing
Concannon opened by stating that
BATS is one of the largest exchange operators for ETFs, and hosts over 40
percent of on-exchange ETF trading. Concannon
claimed that, on August 24th, “ETFs were not the problem,” rather he
argued that the “markets failed ETFs.” Concannon also noted that despite a
“wall of message traffic” and the “enormous” volume of trading flows that day,
there were no technical glitches. He
argued that while the LULD worked “perfectly as designed,
[. . .] the design had flaws.” For
instance, he recalled that some trading halts were implemented once the
security price was recovering from a fall, however the LULD mechanism was
restraining the price from coming back up to its natural level.
Concannon put forth three
recommendations based on his observations of August 24th: 1) opening
primary markets near 9:30 am whether manual or automated; 2) re-evaluating
LULD, as well as how halted stocks are re-opened; and 3) extending the limit
state period (which is usually limited to 15 seconds) rather than halting
trading.
Samara Cohen, Managing Director – Head of US iShares Capital
Markets, BlackRock, noted that many things worked well on August
24th, despite significant problems during market opening. She claimed that the use of market and stop
loss orders exacerbated selling pressure and contributed to pricing
dislocations. Cohen highlighted several
recommendations from BlackRock’s recent whitepaper to improve ETP pricing in the
future, including: 1) harmonizing trading rules across the ecosystem; 2)
educating investors about how to navigate the modern U.S. equity market; and 3)
making changes to market microstructure, such as recalibrating LULD,
standardizing price bands throughout the day, and considering whether to invoke
market-wide circuit breakers during market-wide stress events.
Brendon Weiss, Co-Head, Government Affairs,
InterContinental Exchange (ICE), explained that NYSE Arca lists approximately
85 percent of ETPs, and noted different structures used by NYSE and Arca,
principally that NYSE runs a traditional model with human interventions while
Arca is a fully automated system. He
explained that the NYSE Group believes strongly that delaying market opening is
important during stress events to reduce volatility once the exchange is
open. Weiss noted that there are several
lessons learned during August 24th, and that LULD worked “as
designed” but exposed gaps on areas that can be improved significantly. Weiss called for better investor and issuer
education on how collars work, particularly during the opening mechanism. He also echoed calls for considering changes
to LULD, market wide circuit breakers, reference prices, and considering
whether double wide percentages are necessary near market open and close.
Weiss also mentioned that he is the
chair of the Tick Size Pilot and said it had “taken a while” for self-regulatory
organizations (SROs) to put out rules, FAQs, and data collection exercises. He also
noted that the FAQs were published last week and were developed with
considerable industry input and expressed the need for a six month time
extension.
Question and Answer
When asked why the price
dislocations experienced on August 24th were a U.S. market
phenomenon, Cohen explained that U.S.-listed ETFs that invest in U.S. assets
usually do not use valuation models that incorporate adjacent prices (from
futures markets, etc.). Concannon also
added that NAV is a “great guide” on market pricing, but since it is based on a
past day’s closing price, it is not a reliable price indicator in real
time.
In response to a question regarding
the drivers of volatility on August 24th, Concannon noted that the
U.S. marked opened down due to concerns about the Chinese market, as well as
other factors.
Market practitioners also discussed
the post-halt reopening process and whether it should be a differentiator
between competitors. Weiss called for
aggregating the auctions across trading venues to concentrate liquidity. Concannon agreed that different trading
venues should hold an identical re-opening auction after trading halts (at the
same time under the same rules), insisting that it should not be a competitive feature
of trading venues.
A committee member asked whether
LULD exacerbates problems, despite the fact that it was implemented to reduce
market volatility. Concannon claimed
that single stock LULD is “absolutely” necessary and explained that it works
“quite well” on most days. Cohen agreed,
adding that the number of LULDs on August 24th raises questions
about how it reacts during market-wide stress events, rather than in response
to idiosyncratic events. She called for
limiting actual halts, by extending the limit state to help market makers have
enough time to provide the necessary liquidity.
Weiss agreed and explained that the overarching message is that the market
“needs[s] to incentivize liquidity provision through rewards.”
FASB Materiality
Proposal
James Schnurr, SEC Chief Accountant,
noted that the Financial Accounting Standards Board proposed improvements to its disclosure
framework, specifically on “materiality.” He explained that the proposal is
currently out for public comment and thus he could not say whether he supports
the changes. However, Schnurr highlighted that the proposal is meant to be a
clarification and is not intended to change how preparers and auditors look at
materiality. He noted there has been disagreement around management’s ability
to determine if a disclosure is material and whether they have the ability to
omit immaterial information. He then explained the proposal states that if
management and an auditor agree that the disclosure is not material, then it
does not need to be treated as an error.
Silvers stated that changing the
broad terms of the definition of materiality could have a large impact and
reduce the overall amount of disclosure. He said that from the public’s
perspective, more disclosure is better than less and that this should give the
SEC’s accounting division impetus to intervene.
SEC Enforcement
Priorities
Andrew Ceresney,
Director of the SEC’s Enforcement Division, explained that the SEC’s mission is
to protect investors and noted that micro-cap fraud has been an area of focus.
He said the SEC has created a micro-cap task force comprising 30 full-time
attorneys that work with criminal authorities and focus on “key players” and
“gatekeepers.”
Ceresney also noted that the
Division of Enforcement has been working to address 1) pyramid schemes; 2) offering
frauds and Ponzi schemes; 3) large financial institution misconduct; 4) market
structure violations; 5) Reg SHO violations; and 6) misconduct in the sale of
complex financial instruments.
Donald Langevoort,
Professor at Georgetown Law School, said that securities laws are “woefully
unenforced” and misconduct “far exceeds” the reach of the SEC’s enforcement
division. He stressed that the Department of Justice (DoJ) and the SEC are
under-funded and that enforcement cases must be triaged as a result.
Question and Answer
Carcello asked if the Division of
Enforcement looks at the inspection reports of the Public Company Accounting
Oversight Board (PCAOB) and if enforcement actions are taken against audit
committee members. Ceresney said that a number of cases have been brought
against audit firms and audit committee members and said his division does
generally look at PCAOB reports.
Goettsch asked if Ceresney supports
the Stronger Enforcement of Civil Penalties Act (S.1730) put forth by Sen. Charles Grassley
(R-Iowa) and a bill to extend the statute of limitations for certain SEC
actions (S.1960) put forth by Sen. Jack Reed
(D-R.I.). Ceresney said he is supportive
of both pieces of legislation, noting that changing the statutes of limitations
would be the “easier one.” He added that the DoJ has a longer statute of
limitations than the SEC, but that the two “should be parallel.” Ceresney then
said that if SEC penalties affected investor losses more directly they would
have a bigger impact and pose a larger threat to deter misconduct.
Brown noted that administrative law
judges (ALJs) are not appointed by the head of the agency and that some courts
say this system is unconstitutional. He suggested that the SEC Chair could
appoint these judges or delegate the authority to do so, to avoid problems with
constitutionality. Ceresney explained that ALJs are employees, not officers,
and said he does not think the SEC has to solve a “constitutional problem,” because
he does not “see it as such.” He continued that administrative proceedings are
a “fair forum” and that Congress gave the SEC the authority to choose where
cases are heard. Ceresney added that the agency will do what they can to
advance their mission of protecting investors and said that while he has heard
many complaints about ALJs, he has not heard any complaints about them from
investors.
Wallman asked why bad actors are not
put in jail more often and expressed concern that while individuals are punished
at small firms, they are “insulated” from punishment at large firms. Ceresney
said that prison and action against individuals is the “greatest deterrent”
against misbehavior, adding “this is what we go for.”
More information about
this event can be accessed here.