SEC Commissioner Said SROs Should be Part of Holistic Market Structure Review

If the SEC undertakes a holistic review of equity market structure, “there should be no sacred cows,” SEC Commissioner Dan Gallagher told industry executives attending the SIFMA Market Structure Conference in New York City.

Gallagher, who was interviewed by CNBC Editor Bob Pisani, conveyed that the SEC is a big bureaucracy that tends to protect its own rule book, meaning Reg NMS, and order handling rules, many of which have had unintended consequences.

The topic of SROs, along with market glitches and the potential for a holistic review of market structure surfaced several times at the SIFMA Market Structure conference on Thursday.

“The current market structure based on the concept of SROs and the regulatory structures in our rule book and the market forces around those two, need to be fully examined,” said SEC Commissioner Gallagher in an armchair interview with CNBC’s On Air Stocks Editor Bob Pisani.

Gallagher raised questions about whether it's right for exchanges to be SROs when they outsource the SRO function to FINRA, and also is it right for the SROs to be subjected to certain burdens that are not imposed on alternative trading systems (ATSs). He also asked how much value does the SRO role provide in today’s markets, and how much does that constrain exchanges from competing with brokers that run ATSs.

The topic of whether SROs should have immunity has been controversial due to recent market glitches, particularly since Nasdaq had a market glitch on Aug. 22 that shutdown trading for three hours. By contrast, broker dealers are held liable for systems mishaps that cause market disruptions. Yesterday Knight Capital Group was fined $12 million by the SEC for violating the agency’s market access rule for failing to prevent millions of erroneous orders from entering the market.

“I think liability is one of the main issues,” said Gallagher, noting that immunity is one of the main advantages of being an exchange in the view of broker dealers and ATSs, which is not something they don’t enjoy. For them, they have to honor their contracts.

Market glitches with Goldman Sachs and Nasdaq’s SIP were also discussed and whether Reg SCI — an acronym for Regulation Systems Compliance and Integrity— is the proper way to address these technology issues.

The Commission proposed Reg SCI in March of 2013, and is currently in the process of reviewing the comment letters, according to Gallagher . He characterized the letters as “ meaty” and said that participants both SROs and ATSs, felt that SCI was “too much, too fast.”

Gallagher indicated there is more “refinement” of the rule that needs to happen and that it’s not going to happen this year, but will be high on the SEC’s agenda for 2014.

Pisani asked Gallagher if the exchanges were investing enough in technology so they can handle the traffic, suggesting there is less investment because the stock trading business is lousy. “No regulation is going to stave off glitches,” said Gallagher. He also said that the systems are so connected and in some ways that’s great because it build in redundancies and in other ways it’s awful.

But Gallagher said it wasn’t fair to blame market participants, since it was the regulators that mandated the role of the SIP to be used by all the exchanges and ATSs. “We’ve created a single point of failure for government mandates in Reg NMS,” said Gallagher, who made it clear that in any holistic review of market structure regulators would need to review their own rulebook as well.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio