Last week we filed a comment letter with the U.S. Securities and Exchange Commission expressing support for a holistic review of Regulation NMS under the Regulatory Flexibility Act (RFA). The RFA requires an agency to review its rules that have a significant economic impact upon a substantial number of small entities within ten years of the publication of such rules as final. The purpose of the review is “to determine whether such rules should be continued without change, or should be amended or rescinded…to minimize any significant economic impact of the rules upon a substantial number of such small entities.”[1]

A Review Overdue

Reg NMS is now almost 12 years old. The SEC intended to begin a review of equity market structure, including Reg NMS, when it issued the Concept Release on Market Structure in January 2010, nearly five years after its implementation. The 74-page Concept Release was to be the cornerstone of the SEC’s equity market structure review by seeking public comment on a broad range of issues including whether: the rules have kept pace with changes in trading technology and practices; execution quality statistics and order routing disclosures in Rules 605/606 needed to be updated; high frequency trading firms need to be registered; and should market makers have obligations. Additionally, the SEC was also looking for insight into other market structure topics such as co-location and latency; the impact of undisplayed liquidity; “trade-at”; depth of book protection; and updating Regulation ATS. The Commission received, in total, 302 responses to the Concept Release, with 218 comments submitted in 2010 and another 84 comments submitted in subsequent years. The Staff also documented over 120 Concept Release meetings with the public.

The SEC has been dealing with many of the issues raised in the Concept Release through rulemaking and guidance, but in piece-meal fashion.

For example, technological and market developments have caused the Commission to “reinterpret” aspects of Reg NMS. Instead of engaging in rulemaking, the Commission recently interpreted the term “immediate” under Reg NMS Rule 600(b)(3) to approve IEX’s application to register as an exchange. The SEC avoided the rulemaking process and the opportunity to conduct a Reg NMS review by issuing guidance. In interpreting the term, in a piece-meal fashion, the Commission has created yet another additional layer of complexity on top of an already complex regulation.

Complexity continues to expand with each new or amended exchange rule filed with the Commission, including new order types, co-location services, and proprietary market data fees that strike at the very heart of fairness and add to the complexity of the market. It is troubling there is no look-back in place to determine if guidance or SRO rules, some of which were approved years ago, may have a different effect on order and price competition today. Moreover, it is almost sacrosanct that new SRO order types based on prior approved order types automatically be approved without any consideration given for the order type’s fairness and validity given today’s technology and market structure.

Since 2005, the Commission has also been engaged in a significant number of rulemaking efforts in addition to those that were an outgrowth of the Dodd-Frank Act. In our comment letter we urged the Commission to evaluate Reg NMS against Commissioner Gallagher’s “Crazy Quilt Chart of Regulation” that displays the multitudinous rules adopted since July 2010 that are applicable to a financial services holding company. Given the layers of new regulations and additional complexity, it is appropriate to examine whether the framework of Reg NMS is achieving the SEC’s mission of investor protection, maintaining fair, orderly and efficient markets, and the facilitation of capital formation.

The Public Interest

In our opinion, the volumes of pages in comment letters submitted in connection with the Concept Release, the 477 comment letters in relation to the IEX exchange application, the 86 comment letters filed since 2014 on the Commission’s Equity Market Structure Advisory Committee, many focused on Reg NMS issues, and the numerous legislative letters, including the JOBS Act directing the SEC to conduct a market structure pilot, are an indication of the public’s desire to conduct and participate in a holistic review.

The RFA provides an opportunity for the Commission to conduct an assessment of the cumulative effect and overall efficiency of the Reg NMS rules.

[1] See 5 U.S.C. 610(a).

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