Back to General Resources

HFSC SRO Hearing

House Financial Services Committee Subcommittee on Investor Protection,

Entrepreneurship and Capital Markets

Oversight of America’s Stock Exchanges: Examining Their Role in Our Economy

Wednesday, March 30, 2022

Topline

  • Full Committee Chair Waters stated she was very pleased to be considering proposals to strengthen corporate governance and limitations on exchange legal immunity. Subcommittee Chair Sherman highlighted and Rob Jackson explicitly supported Sherman’s Securities Exchange Reform Act of 2022 to limit the legal immunity of the exchanges in their commercial activities, address rule-based limitations on liability, and provide non-SROs voting representation in NMS initiatives.
  • Subcommittee Chair Sherman and Full Committee Chair Waters criticized the major exchanges for not attending the hearing.
  • Questions focused on exchange liability, market data fees, money laundering, pilot studies, IPOs, CAT data, and the SEC rulemaking process.

Witnesses

Opening Statements
Chairman Brad Sherman (D-Calif.)

In his opening statement, Sherman explained the history of the exchanges and their transition into publicly traded companies acting as both regulatory and for-profit entities, noting their sale of market data. He described SEC rules around fees and National Market System (NMS) boards and the exchanges’ lawsuit blocking the NMS regulation that would have allowed broker dealers a seat on the exchanges’ boards. He also highlighted investor losses after exchanges used their self-regulatory organization (SRO) authority to cap their liability. He then focused on the data process and NMS process of the exchanges, liability, and governance standards for publicly traded exchanges. Sherman also discussed alternative trading system (ATS), dark pools, and increased trading in that area.

Ranking Member Bill Huizenga (R-Mich.)

In his opening statement, Huizenga explained multiple instances in which he believed the Subcommittee should have taken action on different policy matters, including the SEC’s use of 30-day comment periods for its rulemaking proposals. Huizenga expressed concern over the absence of the exchanges, which were invited, at the hearing. Sherman clarified after Huizenga’s statement that representatives from major exchanges refused to attend the hearing.

Committee Chairwoman Maxine Waters (D-Calif.)

In her opening statement, Waters highlighted the absence of the major exchanges at the hearing and stated she was very pleased to be considering proposals to strengthen corporate governance and limitations on exchange legal immunity.

Testimony

Robert J. Jackson Jr., former SEC Commissioner and current Professor of Law, New York University School of Law

In his testimony, Jackson cited competition as a solution to the problem plaguing the exchanges, adding that the exchanges have used litigation and lobbying to stall important progress on ensuring competition. He further discussed lack of competition – expressing support for the Securities Exchange Reform Act of 2022 in his written testimony – the end of exchanges as corporate governance gatekeepers, the exchanges’ use of power of listings to benefit its own floor brokers at the expense of price efficiency, and the role of retail wholesalers in modern markets. He closed by recommending that Congress provide the SEC with the authority it needs to ensure that its rules adequately promote competition.

Michael S. Piwowar, Executive Director, Milken Institute Center for Financial Markets; former Commissioner and Acting Chairman, SEC

In his testimony, Piwowar focused on guiding principles for market structure policy, select policy proposals, and investing in America’s future. Piwowar stated any change to market structure policy, including the regulation of stock exchanges, in one area will likely affect other areas. He said because U.S. equity markets and their regulatory framework are so complex, the SEC’s current guidance is a particularly useful tool for evaluating potential changes to market structure and market infrastructure policy. He added that since markets and technologies are continually evolving, frequent retrospective reviews of market structure rules by the Commission are necessary to ensure that they are not outdated, obsolete, or overly burdensome.

Ellen Greene, Managing Director, SIFMA

In her testimony, Greene, the only witness to represent communities in every district served by members of the Subcommittee, provided a brief history of the development of the exchanges starting with their codification in the Exchange Act and their transition into publicly traded companies in the early 2000s, which imposed on them a duty to maximize profits, resulting in their selling market data and other products to broker dealers whom they compete with for order flow and execution services. She highlighted that the exchanges’ duty to shareholders presents a conflict of interest with their regulatory duties, adding that this conflict is made worse by special privileges granted to them prior to becoming for-profit entities. She used the example of the exchanges’ exemption from private liability in the course of their regulatory duties while seeking to expand that immunity to their for-profit activities. Greene also emphasized the exchanges’ imposition of non-negotiable, unreasonably low private liability limitations on damages for, for instance, a Consolidated Audit Trail (CAT) breach, the exchanges’ unique right to sell and price their data products to captive customer broker dealers, the exclusion of competitors from full participation in the exchanges’ National Market Structure (NMS) plan initiatives, and the exchanges’ access to CAT data through their overlapping regulatory jurisdictions. She concluded by stating that the powers that for-profit exchanges have to regulate and set the costs for their customers and competitors make our equity markets less fair, competitive, efficient, transparent, and inclusive and that this harms the investing public.

Nandini Sukumar, CEO, The World Federation of Exchanges

In her testimony, Sukumar stated the exchanges work hard to ensure robust infrastructure, including cybersecurity and operational resilience, citing their performance during the pandemic relative to the operational difficulties she says were experienced by broker dealers. She touted the exchanges’ role in price formation and stressed that the exchanges create the marketplace and the flow of price information but do not participate in it, acting as an impartial facilitator of business. She concluded by characterizing the exchanges as trusted third parties that fulfill considerable statutory obligations and are both highly regulated and transparent, adding that all rules and charges are filed with the SEC and publicly available

Manisha Kimmel, Chief Policy Officer, MayStreet

In her testimony, Kimmel explained that the regulatory structure for exchanges has not kept up with today’s market structure. She recommended that Congress: (1) rescind the “effective upon filings” status for Self-Regulatory Organizations (SRO) fee filings; (2) create a clear mechanism for the SEC to review and remand filings already on the books in light of market and regulatory developments; (3) provide definitive guidance on the definitions for each of the requirements imposed by the Exchange Act, as they relate to SRO and National Market System (NMS) plan fee filings; and (4) give the SEC direct control over the public market data stream. Kimmel concluded by recommending that Congress modernize oversight of the exchanges to ensure that investors have warning of changes to exchange fees, that changes to fees not be retroactive, and that fee changes do not go into effect until after the SEC affirmatively determines that the fees are reasonable, equitably allocated, not unduly burdensome on competition, and not discriminatory.

Question & Answer

Liability

Sherman asked how a clarification of the exchanges’ liability standard would help market participants. Greene said clarification and changes to this liability standard to make exchanges responsible for damages they cause in their for-profit capacity are important because exchanges hide behind their regulatory shield adopted back in 1934 and have evolved since then, and special privileges like their liability should be addressed by legislation so that they are more similar to other private companies that do not enjoy immunity in their commercial activities. She also recommended addressing the limitation of liability issue and the exchanges setting artificially low caps so that when there are incidents like Facebook’s IPO, there is adequate funding or ability to sue exchanges in court in order to compensate investors for losses. Rep. Bryan Steil (R-Wis.) asked if there are any global examples that Congress can look out outside of the U.S. structure to gain insight about the liability conversation on stock exchanges. Greene said the regulatory structure in the U.S. is unique with respect to the various privileges it provides the exchanges, such as certain legal immunity, rules-based liability caps, and the exclusion of industry members from NMS initiatives. Sukumar said that, across the world, legal liability immunity is standard because the exchanges need to do certain things to operate markets.

Market Data Fees

Sherman addressed exchanges’ control over market data and asked if this creates disincentives for exchanges to improve the quality of the market public data when they have a competing product that sells for more. Kimmel said it absolutely does but countered by explaining the different types of proprietary fees.

Money Laundering

Rep. Sean Casten (D-Ill.) asked Jackson to discuss the exchange perspective of Russian money laundering and if a same party executes the same trade on two different markets, if the U.S. exchange can monitor that trade, what U.S. exchanges are monitoring right now. Jackson said the exchanges have done well to collaborate internationally to combat money laundering but highlighted his concern that Congress had to pass a law – the Holding Foreign Companies Accountable Act – in the first place requiring exchanges to be more careful with the kind of foreign companies Americans are trading with. Casten then asked if there are gaps in reporting and regulating structures where there is a money laundering concern. Sukumar said every exchange is interested in addressing money laundering and emphasized the transparency of the exchanges.

NMS

Rep. Warren Davidson (R-Ohio) asked what can be learned from the existing structure and what aspects of the National Market System (NMS) can be emulated for a future crypto exchange framework. Piwowar said the U.S. exchange markets are very complex, and so is crypto, adding that looking at the economic analysis and cost benefit analysis and evaluating it over time is important.

Pilot Studies

Rep. Alexander Mooney (R-W.V.) asked Piwowar to elaborate on his pilot study recommendation from his written testimony. Piwowar reiterated his support for pilot studies but also expressed support for limitations and guardrails around them due to their high cost and potential for failure, while noting that failure is useful for discovering what not to do. He added that pilot studies should be done through a notice and comment rulemaking instead of through an NMS plan and recommended that Congress give the SEC authority to engage in pilot studies.

IPOs

Rep. Tom Emmer (R-Minn.) asked if the Main Street Growth Act could eliminate some of the barriers deterring small growth companies from going public. Piwowar said yes, that the bill addresses the fact that the trading system is set up for larger public companies, and that the exchanges are not incentivized to innovate and experiment because of unlisted trading privileges and lack of competition among the exchanges. Piwowar agreed with Emmer that there is a timely need to pass the Main Street Growth Act.

CAT Data

Huizenga asked Greene to share her perspective on the SEC’s proposals regarding the CAT. Greene stated that SIFMA is in full support of CAT; however, there remain a lot of data security issues and privacy concerns that have not been addressed. She added that the SEC proposal put forth by former SEC Chair Jay Claton was supported by SIFMA and would have kept the data within CAT, adding that when evaluating CAT, the possibility of a breach is more of a when than an if. She lastly noted SIFMA’s support of the American Customer Information Protection Act of 2018 in addressing concerns of a CAT breach.

SEC Rulemaking

Huizenga asked about the SEC’s pace of rulemaking. Piwowar commented on the short comment periods relating to new proposed rules by the SEC, gave his objection to the 30-day comment periods, and added that short comments periods have a negative impact on average everyday Americans who do not have the time to read through lengthy proposals. He said the number of proposals being published is also alarming and does not provide adequate time to comment on the proposals. Davidson asked if long, drawn-out enforcement actions selectively applied are effective or if clear rulemaking is more effective. Piwowar stated clear rulemaking is more effective. Rep. Anthony Gonzalez (R-Ohio) asked what Piwowar’s thoughts were on the SEC requiring private companies to disclose more information as if they were public but without any of the benefits of accessing the public markets. Piwowar stated that he does have concerns about this and worries about the unintended consequences of companies starting to move overseas because of the requirement.

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.