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Regulators and policymakers alike have expressed a seemingly sudden interest in overhauling the way stocks and stock options are traded. There are several reasons. Investor protection has become a populist issue, because more than 76 million Americans now own stock directly or through mutual funds and retirement accounts. A March 2000 Gallup survey revealed that 61 percent of American adults own shares. At the same time, new technologies make it possible to trade shares more quickly than ever before, often replacing many people with a few computers. Internet-based brokerage firms offer commissions one-tenth as large as those charged by traditional brokers. Established financial markets face competition from brokerage firms that match up their own customers’ buy and sell orders, and from innovative trading institutions like Electronic Communications Networks (ECNs), which allow buyers and sellers to trade directly with each other.
Amidst all this change, two related issues have sparked concern in Washington: “market fragmentation,” and the prices charged for “market data.” Fragmentation occurs whenever a security trades in multiple locations, and traders in one location cannot easily trade with those in the other location. Fragmented markets might deprive some buyers and sellers of the opportunity to trade at the best possible price. Market data consist of securities price and quotation information sold by several consolidation networks on behalf of the stock markets that produce the information. Regulators fear that the networks selling the data are monopolies that charge excessive prices. The Securities and Exchange Commission (SEC) has solicited comments on both sets of issues.
Securities regulation can be quite arcane, but the fundamental issue is simple: will regulation promote centralization and stagnation, or will it promote diversity and innovation? Unfortunately, many regulatory proposals are heavy on centralization and light on innovation. To make matters worse, the perceived problems they seek to solve were often created by existing law and regulation. If regulators genuinely seek to promote investor interests, they will take competition, diversity, and innovation as their watchwords.
In the 1970s, Congress and the SEC sought to create a “National Market System” for stocks by establishing centralized systems for reporting price information and facilitating trade across different equity markets. Unfortunately, the Intermarket Trading System can no longer keep pace with varying speeds of innovation in many different equity markets. Treating the dissemination of price data as a monopoly public utility has led the SEC to the edge of the price regulation swamp, and we can only guess whether the commission will plunge right in or recoil in horror once it considers the experience of other utility regulators.
No one quarrels with the fundamental goal of reducing information and transaction costs. However, the results of federal policy suggest that centralization, standardization, and monopolization impose substantial costs on investors. Additional regulations that seek to address problems created by this approach will only plunge the SEC ever deeper into micromanagement of the financial industry – a result the commission says it historically has tried to avoid.
Innovation and diversity can best be promoted through voluntary, bilateral trading links and competing information dissemination networks. To accomplish these goals, regulators and legislators should forbear from forcing the financial industry to develop a centralized set of trading links to replace the outmoded Intermarket Trading System. In addition, the SEC and Congress should explore strategies to promote competition in market data dissemination. These policies would allow financial firms and stock markets to compete by offering investors a diverse array of information and trading opportunities.