(Bloomberg) -- It’s an arcane, technical part of stock-trading, part of the hidden plumbing behind every click to buy or sell.
But for those who run, regulate and trade in U.S. equity markets, it’s become a battlefield.
At issue are rebates -- the payments that exchanges make to top traders and brokers for sending them their business. The point of contention is a two-year government pilot program -- a Securities and Exchange Commission experiment -- designed to determine whether rebates influence the locations where trades are made.
The dispute pits the New York Stock Exchange, Nasdaq Inc. and Cboe Global Markets Inc. -- which run the top U.S. marketplaces -- against the SEC, asset managers and pension funds such as the California Public Employees’ Retirement System. Money managers say rebates can create conflicts of interest. The agency wants to determine whether this is true, but exchanges say the study would needlessly disrupt markets. Personal attacks have been lobbed. Industry panels have devolved into mudslinging. Lawyers have been unleashed.
“Everyone’s suing each other,” said Spencer Mindlin, an analyst at Aite Group LLC. “It’s crazy.”
The tone is so heated that Mindlin used the tagline “an age of outrage” for a June conference in New York. Several speakers said the description was spot on.
Just about all participants agree that U.S. stock markets are the most efficient in the world. Their relative transparency means that when the SEC proposes changes to market rules, or exchanges request permission to alter their operations, the agency receives a deluge of feedback.
What’s different this time is the rancor.
The SEC program, approved in December, is called the Transaction Fee Pilot. The study would temporarily divide stocks into three groups: one would ban exchanges from offering rebates to brokers, another would cap fees at $0.001 a share and the last would be a control group. The aim is to figure out whether the fee structures are good or bad for the market, according to a filing. It’s now being held up in court.
The program represents a “remarkable regulatory power grab,” according to the three exchanges, which sued the SEC in February. They say it could harm investors who may have to pay higher prices for stocks, and hinder companies that issue stock from raising money. They say the “fatal shortcoming” in the SEC’s plan is that its drawbacks are likely to outweigh the benefits. Exchange executives argue that Main Street investors have never had it better: It’s easier, faster and cheaper than ever to buy and sell shares.
“It’s in part contentious because it’s so damn complicated,” Chester Spatt, a finance professor at Carnegie Mellon University and former SEC chief economist. “The rebate is going into the brokers’ pockets and it doesn’t go to the customer.”
Some of the world’s biggest asset managers and pension funds, including CalPERS and the Ontario Teachers’ Pension Plan, support the pilot. Industry groups representing funds that manage almost $70 trillion argue that the rebates can tempt traders to seek profits at investors’ expense.
In separate comment letters in May, BlackRock Inc. and Vanguard Group Inc. both said they “strongly” support the pilot’s goals.
Another subject of debate: market-data fees charged by the exchanges. The costs are a lightning rod for banks and buy-side firms that purchase super-fast, detailed information about stock-trading in order to show that they’re getting the best deal for clients.
The Securities Industry and Financial Markets Association, which represents U.S. broker-dealers, estimated its members’ spending on NYSE market data rose 1,100% between 2010 and 2017. Exchange executives say that revenue from market data has grown modestly.
A federal appeals court is reviewing an October ruling by the SEC that found NYSE and Nasdaq had failed to justify some data-fee increases. The regulator also refused to approve other fee increases that were contested by Sifma and Bloomberg LP, the parent company of Bloomberg News, which is an associate member of the industry group.
In the past year, legal clashes over the pilot program have injected an unusual level of drama into relationships that in the past have been collegial.
“A lot of people are angry,” said Mehmet Kinak, global head of systematic trading and market structure at asset manager T. Rowe Price Group Inc., which is among the pilot’s backers. “It’s much more confrontational than it used to be.”
Privately, current and former SEC officials say they’ve never seen anything like it.
Case in point: In June, NYSE and Nasdaq alleged Brett Redfearn, the director of the SEC’s trading and markets division, had “improperly influenced” commission proceedings on market data because of his Wall Street background. Before joining the regulator in late 2017, Redfearn was global head of market structure for JPMorgan Chase & Co.’s corporate and investment bank, as well as chairman of SIFMA’s equity markets and trading committee. The SEC’s process was “tainted” by Redfearn’s involvement, the two exchanges said in a legal filing.
Targeting Redfearn was a step too far, said several industry executives. They praised Redfearn for his intelligence and knowledge of equity-market structure.
“Brett has done and continues to do important work on behalf of investors and our markets,” SEC spokesman John Nester said in a statement. “His participation in this matter has been thoroughly vetted and deemed permissible by our ethics office.”
The infighting has created an opening for new marketplaces, such as Long-Term Stock Exchange, a Silicon Valley startup that won approval from the SEC in May to open a new trading venue. IEX Group Inc. is a regular critic of the legacy players. It supports the SEC pilot and doesn’t offer rebates or charge for market data. And some of the biggest U.S. market makers, including Bank of America Corp., Citadel Securities, E*Trade Financial Corp. and Virtu Financial Inc., formed their own Members Exchange earlier this year.
The situation has become even more tense as participants come under pressure to cut costs at a time when profits from equity trading are shrinking.
“Every fee you charge is a nickel out of my pocket, and the revenue is not enough to float all the boats -- all the boats are starting to attack each other,” said Larry Tabb, founder of research firm Tabb Group LLC. “This is worse than I’ve ever seen it. I’ve been in the industry since the 1980s. I’ve never seen this level of acrimony.”
--With assistance from Ben Bain.
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