Forget the Short Squeeze David vs. Goliath Battles: The Real War is Between Exchanges and the SEC, With Retail Investors in the Crosshairs

Shah Gilani|February 12, 2021

In case you haven’t noticed, and not many investors have, there’s a war going on right now between the exchanges and the SEC over the public’s right to get the same stock bid and ask price data that hedge funds, high frequency traders, and banks, pay through the nose for.

What you may know is, the exchanges operate what regulators and detractors call a two-tier system, providing the most basic “national best bid and offer” (NBBO) data to the public while selling “deep book” bid and offer price and size data via expensive “private feeds” to big boys.

The Securities and Exchange Commission is out to level the field for the little guys, but the exchanges are suing to stop new rules from being enacted.

The tail is wagging the dog these days and it’s making the exchanges nervous. They are trying to keep retail down and out, but a war is being waged in court to settle this once and for all.

Here’s what the war’s about and depending on if it’s won or lost, who wins and who loses.

Let’s jump in…

Exchanges Versus the SEC: Changing Rules to Benefit Retail?

Back on February 14, 2020 the Securities and Exchange Commission (SEC) filed a 600-page rule change proposal regarding important stock price data the exchanges control.

Exchanges receive thousands sometimes millions of orders every second of every day to buy and sell specific amounts of stocks at specific prices. They take all the bid and offer data coming into their “pipes” and consolidate it into what’s called the National Best Bid and Offer, the NBBO.

The NBBO shows how many shares of a stock are being bid for at the highest price and how many shares are being offered at the lowest price. That’s what the public sees.

But there’s more, a lot more. Exchanges have all the bids and offers, and all the size amounts being bid and offered at all prices. All that data constitutes “the book” and because there are many levels of bids and offers, seeing that data, or into the “depth of the book,” gives viewers, especially computers, enhanced insight into whether there’s more buying interest or selling interest in any stock and at what price levels.

Exchanges sell deep book data for a lot of money. Hence, the two-tier system of stock data.

The February 2020 rule proposal was approved by a unanimous vote of the SEC’s five Commissioners on December 9, 2020. The new rules now face a 60-day comment period.

Here are the most important rule changes:

Exchanges would be required to show buying and selling interest, not just at the current bid-offer price for a stock, or the NBBO, but at the next five price levels up and down. That “depth-of-book” data can show, for example, whether buy orders for a stock are thinning out, which could mean a falling price.

Exchanges would also have to make available their book data on every stock to so-called competing consolidators, and to broker-dealers who would be free to consolidate that data on their own.

And, under the current system, securities information processors (SIPs) only display the best bid and offer prices for “round lot” orders, those in multiples of 100 shares, such that investors don’t see buyers or sellers quoting prices for stocks in quantities smaller than 100 shares, called “odd lots.”

The SEC’s new plan redefines what counts as a round lot. In the case of stocks with share prices above $1,000 but no higher than $10,000, a round-lot order could be just 10 shares. That will force SIPs to display more detailed quote data for stocks.

All that is to say that information once kept behind closed doors and paywalls would go public, leveling the playing field for retail traders. But the exchanges don’t want to go down without a fight.

The Lawsuit: Exchanges Fight for Profit

Earlier this week, in parallel court filings, the NYSE, which is owned by Intercontinental Exchange Inc. (“ICE”), Nasdaq Inc. (“NDAQ”), and Cboe Global markets Inc. (“CBOE”) sued the SEC in the U.S. Court of Appeals for the District of Columbia Circuit, claiming the SEC’s rule changes are “overreach” and amount to unconstitutional seizure of property.

What’s at stake for the exchanges is revenue, a lot of revenue from selling deep book data. In 2020, “Information Services” commanded $6.8 billion in revenue for the global exchanges, or 18.85 of their total revenue. That’s up from 12.8% of revenue in 2010, according to Burton-Taylor International Consulting.

“The rule is arbitrary, capricious and otherwise not in accordance with law and does not promote efficiency, competition and capital formation,” the NYSE said in its suit.

A spokesperson for Nasdaq echoed the sentiment in a statement to The Wall Street Journal. “The SEC exceeded its authority with this ill-conceived remake of market structure,” they said. “This will make markets more complex and costly.”Cboe and the SEC declined to comment on the litigation.

The war over equal-access to order flow data isn’t just going to impact revenues at the exchanges if they lose in court, it’s going to undermine the insider’s advantage firms who pay for deep book data. Knowing which way stocks may trend because of the ability to see all bids and offers and the size of those orders allows those with access to buy ahead of orders to buy more shares and sell ahead of sell-order avalanches.

That in turn could impact how intermediary high frequency shops, order flow buyers, and market-makers trade, what kind of liquidity they provide and what they pay brokerages.

More directly, retail traders and investors would benefit by seeing into the book for stocks and new trading products and services would flood the market, greatly leveling the playing field for mom-and-pop investors and small traders and investors just getting their feet wet in the wild world of securities markets.

Warm wishes for health, wealth, and happiness,

Shah