The largest U.S. stock exchanges are taking the SEC to court as tensions over their business models reach a fever pitch across Wall Street.
In the wake of a new wave of criticism from Washington, the Intercontinental Exchange Inc.-owned New York Stock Exchange, Nasdaq Inc. and Cboe Global Markets Inc. have gone on the offensive by taking the rare step of suing Wall Street's chief regulator in federal court over a stock market trading experiment that the exchanges have described as overreach and price-fixing.
"We don't take positions like this lightly at all," Nasdaq Senior Vice President of North American Equities Tal Cohen said in an interview. "This [pilot] is a fairly blunt instrument. This is another one of those one-size-fits-all discussions."
Known as the Transaction Fee Pilot, the program was approved by the SEC's commissioners in December 2018.
The green light represented the latest blow to the three major U.S. exchange operators, which had extensively lobbied against the pilot. The SEC brought a new level of scrutiny to the exchanges throughout 2018, scoring a win for the banks, broker/dealers and asset managers who have long claimed that the three exchange families have pushed higher costs onto much of Wall Street and Main Street.
But the exchanges argue that the experiment will cause ripple effects throughout the stock market that could harm a host of market participants with wider spreads and higher transaction costs.
"This truly represents an unprecedented move by the SEC to distort free-market mechanisms that govern the competition among trading venues," said New York Stock Exchange Head of Transactions Michael Blaugrund, who had previously hinted at litigation over the pilot, during a press briefing. "It's really critical that the SEC not have the authority to arbitrarily decide that they want to run an experiment, see what happens and then decide whether that was good or bad."
A Cboe spokesperson said in a statement that the pilot is "intrusive, ill-conceived and likely to harm the equities markets."
The pilot program specifically targets the intricate and unique systems of fees and rebates that most U.S. stock exchanges use to draw trading onto their platforms. Under those structures, exchanges charge some market participants a fee for removing liquidity from the trading venue by completing a trade, while offering a rebate to others who "create" liquidity by posting new orders.
The SEC's pilot will provide regulators with data on whether or not rebates can influence where brokers route their orders, as some market participants have suggested. The pilot will also allow the SEC to assess the 0.3-cent-per-trade fee cap that was determined about 15 years ago.
"There's nothing new or curious about this," said Joe Wald, founder and CEO of independent broker/dealer Clearpool Group Inc., in an interview. "It is really about looking at a system that really is in need of reform."
Roughly 1,500 stocks and exchange-traded products will be included in the pilot, which is slated to last for at least one year. One half of that group will trade with a lower fee cap of 0.1 cent per trade, while the other half of securities will have to trade with no rebates at all.
All three exchanges have repeated the worries aired throughout the pilot program's comment period, including corporate and ETP issuers' concerns that they will be thrust into a competitive disadvantage if their securities are placed within one of the program's buckets. The exchanges have also said the pilot could drive stock trading off exchanges and onto the less-regulated private venues known as dark pools, where roughly 40% of trading currently happens. Primarily run by banks and broker/dealers, dark pools are not included in the pilot.
The New York Stock Exchange, which was the first of the three bourses to file its complaint, plans to pursue a stay order that would effectively halt the Transaction Fee Pilot until the lawsuits are resolved, Blaugrund said. Nasdaq and Cboe followed the Big Board's lead Feb. 15, when they filed their lawsuits with the U.S. Court of Appeals for the District of Columbia Circuit.
"The fact that all three exchange groups are willing to file suit against the SEC demonstrates that they think this is an existential threat," said Jim Angel, a finance professor at Georgetown University, in an interview. "The fact that they are willing to sue the SEC shows that they feel very strongly about this."