Fix the stock market — here’s how

Sen. Elizabeth Warren and best-selling author Michael Lewis have loudly argued that the U.S. stock market is “rigged” and that the Securities and Exchange Commission’s rules for stock trading are not protecting investors.

If these claims were true, then it would be a big deal, because the SEC’s trading rules have a significant and often overlooked impact on investors. For example, thanks to the SEC’s actions in the early 2000s, $10,000 invested in a mutual fund over 30 years would now yield an investor $132,000 instead of $100,000.

But it has been more than a decade since the SEC revised its trading rules, and our markets are in need of reform.

The Committee on Capital Markets Regulation released its blueprint July 28 for how the SEC can fix the stock market. Our blueprint has backing from virtually all segments of the financial industry, including the country’s largest banks, asset managers and hedge funds. And many of our recommendations are consistent with reforms supported by IEX — the country’s newest stock exchange and the hero of Michael Lewis’ bestseller “Flash Boys” that famously argued that the U.S. stock market is rigged. The IEX exchange slows the speed of trading by 350 millionths of a second — to slow down high-frequency traders.

Our blueprint directly addresses high-frequency trading. We explain that high-frequency trading strategies are just modern versions of traditional market-making and arbitrage strategies that have always existed and provide important benefits to investors. We also explain that so-called “dark pools” — private trading venues for stocks that are owned and operated by broker-dealers — provide investors with highly competitive prices for their orders, often beating the best prices available on exchanges.

Our recommendations are:

Strengthen stock market resiliency: We must reduce the likelihood of events like the May 2010 flash crash, when the U.S. stock market lost nearly $1 trillion of value in a matter of minutes and then rebounded just as fast. These seemingly inexplicable events hurt public confidence in our markets.

Unfortunately, the SEC has not made any changes to stop this and other inexplicable problems from happening again. To fix this problem, we recommend tying market-wide trading halts to volatility in a fixed number of stocks. This would help prevent flash crashes.

Improve stock trading transparency: This is a no-brainer. The disclosure rules that apply to our trading markets are outdated, as the SEC designed them in 2000 when stocks were traded on the floor of an exchange, not virtually.

Enhanced disclosures by exchanges and dark pools would allow brokers to better identify the trading venues with the best prices. This would put more money in the pockets of investors, because brokers retain significant discretion about where they will execute a customer’s order. Brokers also should be subject to enhanced disclosure requirements so investors can determine whether their broker is doing his job.

Enhance competition to lower transaction costs: The rules for stock trading provide exchanges with competitive advantages that are increasing trading costs for investors. The committee believes that the SEC should balance the playing field between exchanges and investors.

For example, exchanges have monopoly control over the supply and pricing of stock market data that brokers need. And estimates are that market data is costing investors close to $1 billion a year. While the NASDAQ and NYSE exchanges have argued that this is not a problem, we believe that the SEC could dramatically reduce these costs by allowing for competition among providers of market data. This could include technology companies like Google or Amazon.

The SEC also should consider lowering the fees that exchanges can charge brokers for trading. These fees are too high and are eventually passed onto investors. Estimates are that reducing the fees charged by exchanges would save investors $850 million a year.

Although our markets are not rigged, there is clearly room for improvement. And our blueprint provides the SEC with the direction that it needs to unleash the benefits of a resilient, transparent and competitive stock market.