Stock Market Wars: Brokers v. Exchanges

By Pam Martens: December 18, 2012 

New York Stock Exhange

At 9:30 a.m. this morning, the Senate Subcommittee on Securities, Insurance and Investment will hold a hearing on stock market structure, titled: “Computerized Trading Venues: What Should the Rules of the Road Be?” 

One of the individuals testifying will be Dan Mathisson, head of U.S. Equity Trading for Credit Suisse.  Mathisson is an influential voice, writing a column for Traders Magazine and cited by Advanced Trading magazine for creating the modern algorithmic trading desk. 

According to his prepared written testimony, Mathisson plans to give the Senators an earful on why stock exchanges should be stripped of their status as SROs – Self Regulatory Organizations.  Credit Suisse, for whom Mathisson works, is subject to regulation by the SROs, as are all other broker dealers who are members of exchanges, such as JPMorgan Chase, Citigroup, Morgan Stanley, Merrill Lynch, etc. 

Increasingly, the broker dealers see themselves in competition with the exchanges. Some of the broker dealers are engaging in stealth exchange-like activities called “internalization” where they match their customers buy and sell orders, functioning like an exchange but without transparency or regulation. 

Mathisson doesn’t see nontransparent trading by big, serially fined and disciplined broker dealers as the problem –   the problem is unfair competition from stock exchanges.  Matthison says in his testimony: 

“Within the past decade, our nation’s exchanges have transitioned to a for-profit model, after more than 200 years as not-for-profit, member-owned organizations. Despite their new for-profit status, exchanges have retained quasi-governmental status as SROs (Self-Regulatory Organizations), and exchanges still receive significant public funding through the market data revenue plans. We believe that this new model for the markets has proven itself to be costly to investors, unfair to broker-dealers, and rife with conflicts for the exchanges themselves. We suggest that ending exchanges’ status as SROs and transferring those regulatory responsibilities to FINRA or the SEC would put all market players on a level playing field…” 

Joe Mecane, Executive Vice President and Head of U.S. Equities at the New York Stock Exchange/Euronext will present a very different view at the hearing.  Mecane will testify that: 

“…today more than 3000 securities have over 40 percent of their volume occurring off-exchange in dark markets. In the NYSE MKT listed market, which represents 709 securities, off-exchange trading accounted for 42 percent of the volume in November. This level of off-exchange activity erodes the incentive for market makers to continue to trade the less active securities, has a negative effect on price discovery and threatens to further decrease the incentives for companies to go public… 

“Today, there are around 63 execution venues in the US markets, including 13 exchanges and 50 dark pools. Exchanges find themselves competing more directly with Alternative Trading Systems (ATSs or dark pools) and broker internalization, which are able to employ different practices than exchanges with far less oversight and disclosure. Some of this competition is through cost, some through order handling practices, and much of it is through client segmentation whereby non-exchange venues are able to incentivize their own or third party liquidity provisions based on the nature of the person they are trading against. As a result of this advantage, large broker-dealers continue to move more order flow into their own private trading venues for a ‘first look’ before routing on to the lit public markets.” 

Before Congress can possibly begin to understand the fragmentation in the marketplace and the tilted playing field it is creating against the public investor, it has to get more than a quick peek into the dark, unlit marketplace that is so benignly called “internalization.” 

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