Over the past half century, the SEC’s regulations have become key determinants of the way in which stocks trade and the fees that exchanges charge for their services. The current equity market structure rules are contained primarily in the SEC’s Regulation NMS. The theory behind Regulation NMS is that a system of dispersed markets operating pursuant to SEC-mandated information and order routing links will provide the benefits of consolidation and competition simultaneously.
This paper argues that Regulation NMS has failed in that quest. It has produced fragmented markets and created questionable incentives for market participants, possibly producing socially excessive investments in speed and secrecy. It discourages exchange innovation, provides insufficient incentives for traders to price orders aggressively, requires brokers to act against their customers’ interests, and forces the SEC to act as a price regulator.
The paper contends that the SEC should replace Regulation NMS with three simple design principles—issuer choice, exchange autonomy, and regulatory consistency. These would allow market forces rather than regulatory mandates to determine the design and pricing of trading platforms and the trading strategies of broker-dealers. They would better align the private incentives of trading platforms with the social objectives of improving liquidity and price discovery.