House Democrats Express Misgivings About Some Market Structure Proposals

House Republicans have opposed these proposals for some time, but Democratic skepticism is also emerging.

Democrats on the House Subcommittee on Capital Markets expressed skepticism on Friday at three of the four market structure proposals that the Securities and Exchange Commission introduced in December 2022.

Representative David Scott, D-Georgia, asked Haoxiang Zhu, the director of the SEC’s Division of Trading and Markets, if the SEC would consider implementing the update to Rule 605, which would require brokers to publish monthly quality-of-execution reports so that more trading data is available to the SEC before it implements the other three proposals.

This request mirrors many of the comments on the proposals, which Zhu acknowledged. A spending bill advanced by the Republican-controlled House Committee on Appropriations also blocks all of the market structure proposals except the Rule 605 update. Zhu said he would consider Scott’s and others’ comments.

Scott answered that “using the latest and most available statistics” is critical to evaluating the merit of the other three proposals.

Representative Wiley Nickel, D-North Carolina, said many of his constituents are concerned about these proposals, especially the Order Competition Rule, which would require rapid auctions for certain retail orders to achieve more competitive pricing. Nickel asked Jessica Wachter, the director of the SEC’s Division of Economic and Risk Analysis, who was called to testify, if she would agree that smaller retail orders for less liquid stocks will actually receive reduced execution quality if nobody shows up on the other side of the proposed auction.

Wachter answered that stocks outside the S&P 500 actually received better price improvement in the SEC’s economic analysis of the Order Competition Rule than those inside it and that the analysis suggested this “might not be a concern.”

Swing Pricing

The swing pricing proposal is among those that would be blocked by the GOP spending bill on the recommendation of Republicans on the House Committee on Financial Services. The various blocked proposals in the bill will have to be negotiated with Democrats before anything can be passed, but if Democrats also are skeptical of swing pricing, there might not be much to negotiate on that item.

Voiced opposition to swing pricing from Democrats in Congress primarily revolves around the proposed hard close, which would require trades be executed by 4 p.m. Eastern time. Under current rules, a trade must be received by 4 p.m., but not executed, in order to receive that day’s price for a mutual fund.

The problem for many Democrats is that the SEC proposal would make processing orders for investors on the West Coast very difficult, given that 4 p.m. ET is 1 p.m. PT and 11 a.m. Hawaii-Aleutian time. Representative Brad Sherman, D-California and the ranking member of the subcommittee, said the proposal would have a “horrendously discriminatory effect” on investors living in the Pacific time zone.

Sherman’s time zone concern closely mirrors concerns expressed by other Democrats during a full committee hearing in April.

Mike Hadley, a partner in the Davis & Harman law firm and a member of the Society of Professional Asset Managers and Recordkeepers (SPARK) Institute’s advocacy team, says the concern about time zone discrimination is “a real issue.”

He explains that it takes time for a recordkeeper to process trade orders. He estimates that trades would likely have to be received by 12 noon ET to receive that day’s price. Some retirement plans would have to get their orders in the day before, Hadley explains.

This time zone issue was not invented by the SEC or by swing pricing, but the swing pricing proposal “aggravates it by many times over.”

Sherman also expresses skepticism about the swing pricing mechanism itself, which passes the costs of trading on to the sellers of a mutual fund instead of the holders in order to mitigate dilution and discourage panic selling. Sherman likens this to charging for life preservers or lifeboats. He argues that investors will be less likely to invest in mutual funds if they believe they will be penalized for selling in tough times in the future.

He says swing pricing “seems like the worst idea you could have in trying to achieve our objectives.”

Sherman pressed Wachter to ask if the SEC had done any analysis on whether the swing pricing proposal would discourage investment in mutual funds. Wachter did not offer a direct answer.

Other Democrats at the hearing also pushed back against some of the market structure proposals offered by the SEC.




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