In December 2022, the U.S. Securities and Exchange Commission proposed a host of new rules on capital markets that could potentially upend decades of progress that has been made toward increasing opportunities for retail investors.
A white paper written by the University of Maryland’s Thomas Ernst and Carnegie Mellon University’s Chester Spatt for the Wharton Initiative on Financial Policy and Regulation (WIFPR) analyzed one of the SEC’s capital markets proposals, the Order Competition Rule, which targets payment for order flow (PFOF). PFOF has enabled broker-dealers to provide consumers the benefit of commission-free trading and led to a surge in retail investment.
The paper outlines several issues with the SEC’s proposal and provides alternative solutions to address concerns about PFOF while protecting retail investors. From the white paper:
“SEC has proposed mandating all retail equity orders be executed in order-by-order auctions, but switching to auctions would involve both a tradeoff between competition and allocative efficiency, and concerns about information leakage. Instead, we propose three alternative changes to markets. The first is greater flexibility for Retail Liquidity Programs, which already allow competition for retail market orders. The second is a series of changes to option markets, such as competitive DMM assignments and reduced access fees, which would enhance competition in option markets. The third and final change is a fee cap for PFOF. A fee cap would enable PFOF to continue as a revenue source for brokers, while curbing potential excesses. Imposing a PFOF cap would also reduce broker incentives to encourage trading of any particular asset, avoiding misalignment in the current system. While one should view our proposals as preliminary, they do suggest a potential basis for both broadening the current regulatory debate involving equity market structure and extending the dialogue to potential reforms of option markets.”
Read the full white paper here and watch a recent webinar with the authors here.