Investor Advisory Committee supports pilot test of stock exchange transaction fees

The Securities and Exchange Commission’s (SEC) Investor Advisory Committee (IAC) on Sept. 13, 2018, voted to endorse the commission’s plan to conduct a pilot test of pricing restrictions on stock market trading fees.

In March, the market regulator published Release No. 34-82873, Transaction Fee Pilot for NMS Stocks, to test so-called “maker-taker” fees and rebates stock exchanges use to encourage brokers to trade on their markets. It will also test the reverse “taker-maker” model.

The transaction fees have been a source of considerable disagreement about their effects on the overall market. “The Pilot is intended to produce data that can help resolve that very debate,” the advisory panel said in its recommendation. Most stock exchanges use the maker-taker fee model, in which exchanges pay brokers a rebate to provide trading orders, or “make” liquidity. The exchanges charge a fee to brokers that trade against the submitted orders and “take” liquidity out of the market. The fee is capped at $0.003 per share for stocks quoted at $1 or more and 0.3 percent of the quoted price for stocks that trade for less than $1 per share, according to Rule 610 of Regulation NMS, for National Market System.

Critics say maker-taker pricing creates unnecessary complexities and distorts the market. The fees pit brokers against their clients because the brokers have an incentive to place orders with the exchanges that provide the highest rebates even if the exchanges do not have the best price quotes available for the client’s order.

Proponents, including stock exchanges, say maker-taker fees play a positive role by allowing exchanges to compete with off-exchange trading centers and narrowing the spreads between the bids and offers for stocks by subsidizing posted prices. The off-exchange venues allow large traders to place trades without suffering from a big shift in share price as they execute their orders. Narrow spreads between a buyer’s bid and a seller’s offer for a share of stock are considered beneficial for investors because they lessen the risk that the price will move sharply before a trade can be completed and increase the likelihood that a buyer or seller will reap the profit from the trade.

In comment letters, some companies, including Procter & Gamble Co., The Home Depot Inc. and HP Inc. said they are concerned with the proposed pilot because it might widen the spreads, resulting in higher costs for companies’ stock repurchase program. The wider spread also has the potential to disadvantage one security versus another because of different investor transaction costs. The pilot would also unfairly put transaction fee restrictions on only national stock exchanges while allowing others to compete without the restrictions. If the SEC still goes ahead with the pilot, they asked to be excluded from the pilot.

The IAC said it opposes letting companies opt-out from the pilot.

“Allowing an opt-out could introduce a bias into the test if the companies opting out differed in some important way from those that did not,” the panel said. “This would reduce the reliability of any results generated by the Pilot.”

The SEC is proposing new Rule 610T of Reg NMS to conduct the pilot test of stock exchange transaction fee restrictions across three groups of stocks.

For Test Group 1, the fee would be capped at $0.0015 per share for removing and providing displayed liquidity.

For Test Group 2, the fee cap would be capped at $0.0005 per share for removing and providing displayed liquidity.

Rebates and so-called linked pricing would be banned for stocks in Test Group 3. With linked pricing, stock exchanges discount the fees they charge to brokers for taking liquidity out of the market provided they route a minimum amount of trade orders to the exchange to make liquidity. The Rule 610 cap of $0.003 per share would continue to apply to the fees for removing displayed liquidity.

A control group of stocks would continue to rely solely on the Rule 610 cap for the fees for removing displayed liquidity.

The pilot would last two years with an automatic sunset at one year unless the SEC decides to continue it for another year.

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