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Levitt blasts parochialism
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September 23, 1999: 9:21 p.m. ET
SEC chairman pushes for market links, greater competition and technology
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NEW YORK (CNNfn) - Securities and Exchange Commission Chairman Arthur Levitt fired a salvo today against "parochial interests" in the institutions that govern U.S. stock trading and called for greater competition among and better performance in stock markets, in light of the tumultuous changes in American markets.
In a speech at Columbia Law School, Levitt cautioned, "This is not the time, I think, to cling to the comforts of custom. It is a time to demand value." He urged all involved "to recognize the market as a marketplace, and not an institution."
SEC Chairman Arthur Levitt
Those comments served as a veiled warning to traditional stock markets and their members not to drag their heels. Levitt also leveled explicit criticism in his half-hour address, as he called for the New York Stock Exchange to abolish a restriction on other markets trading certain of its stocks.
Levitt, who two weeks ago became the longest-standing SEC chairman in history, looked lean and poised in a blue suit and pink polka dot tie as he started his speech at 6 p.m. in the law school's Greene Hall auditorium. Columbia is a school with which he has close family ties.
"I feel that I'm among friends," he joked. Though he graduated from Williams College, his grandfather, father and wife all went to Columbia. "I'm the only one who couldn't make the grade," he said.
Levitt, who became chairman in 1993 and whose second term expires in June 2003, had less-friendly remarks to make about the NYSE's market-responsibility rule, or Rule 390. It restricts trading of stocks that listed on the Big Board before 1979 to exchanges, meaning the Nasdaq stock market has no access to them. The rule "should not be part of our future," Levitt said.
The SEC chairman said after his talk that he had little time for markets and market participants "protecting their turf." He urged open access to all markets and cooperation among them. By the same token, if an SEC rule is overly burdensome to one or some parties, it should be changed, he said. "These are parochial problems and need to be reformed," he said.
In general, Levitt's speech was upbeat about the prospects of perhaps the most significant changes ever to face U.S. stock trading. He said the aim of his talk was to raise many of the questions, many of them controversial, that he expects to see hashed out in the near future.
"We have an opportunity today that we may not have again in our lifetime, to realize the vision for a true national market system," Levitt said.
Great challenges ahead
Levitt pointed out that, thanks to technology and competition, the realities of U.S. stock markets have changed so rapidly in recent years that it's difficult even to know what a stock "exchange" is.
For instance, electronic communications networks, or ECNs, "present serious competitive challenges to the established market centers." By cutting the cost of executing trades and providing investors with greater choice, ECNs "have been one of the most important developments in our markets in years, perhaps decades," Levitt said.
He said the SEC aims to foster such competition. But the new pressures and rapid pace of change make these tricky times, he said. Competition works only if it does not lead to greater market fragmentation, he said.
Levitt called upon the leaders of the securities markets to begin a public dialog on technology "to garner the benefits of centrality without stifling competition." He stressed linking markets "within months, perhaps a year or two," and making sure there's an even playing field for all.
Rules can't apply to only one market participant, he suggested. For instance, ECNs charge fees for executing trades that market-maker companies on Nasdaq cannot, Levitt pointed out, and he has directed the SEC to restore "a fair, competitive balance."
Levitt waxed philosophical at times, stressing that regulators and markets need to cooperate rather than viewing each other as adversaries. "Markets exist by the grace of investors," he said, and the guiding principles are clear.
"Price discovery and best execution should be enhanced. Liquidity should be fostered. Interaction between institutional and retail trading should be maintained. Market innovation should be encouraged. And competition among market centers, above all else, should remain vigorous and dynamic."
To that end, he said the SEC did not stand in the way of the efforts by Nasdaq and the NYSE to demutualize and convert to for-profit status. That would rid them of their bureaucratic, member-driven structure and let them compete more effectively.
But such developments do raise questions, notably how markets will regulate themselves, Levitt said. He called for "strict corporate separation of the self-regulatory role from the marketplace it regulates."
After his speech, he said he had told all the markets that he favors their spinning off their regulatory arms, a notion Nasdaq first suggested. He encourages the NYSE to do the same, particularly if it seeks public status.
Questions more than answers
Levitt raised more questions than he answered. He asked, for instance, whether the markets should form a central, virtual limit order book. Should that be combined with electronic access, he wondered. And should markets still be able to cross orders internally at preferable prices, he asked.
The SEC chairman said he favored centralized markets over fragmented ones, particularly if the effect of that fragmentation is that they don't guarantee customers the best prices.
But Levitt cautioned that centrality raises the dreaded specter of a monopoly. "We dare not allow any market structure to take hold that extinguishes the power of innovation," he said.
Levitt praised as "intriguing" the idea that each market could conduct its own regulation and surveillance, while reporting to a centralized regulator for regulation of members, sales practices and other aspects of intermarket trading. The SEC has continued to mull several options of how it would like to see self-regulation continue.
After his talk, Levitt said he could foresee a central regulator that would monitor the financial operations and security of the members of the various markets and track how they treated customers. Each market might then have its own self-regulatory body focused only on how the market's "floor," virtual or real, operates.
ECNs, he said, would likely end up like regional exchanges, most likely contracting with a larger market's regulator to oversee their computerized trading "floor." But at this point, all details are far from set in stone, he explained.
Levitt pointed out that competition has brought significant improvements in how stock markets operate. "More competition can and must be cultivated," he said. In that light, the New York Stock Exchange's Rule 390 "may very well be on its ninth life," Levitt said, criticizing it as "anticompetitive."
Rule 390 restricts the trading of 29 of the 30 stocks in the Dow Jones Industrial Average, for instance, and issues covered by Rule 390 accounted for 48 percent of NYSE volume in August, according to the SEC. The rule has been a major force pushing electronic communications networks, or ECNs, to seek exchange status, so they can offer trading in NYSE stocks.
For now, ECNs can trade Big Board stocks but their quotes aren't linked to the exchange. That limits the trading to participants on the ECN and makes it virtually impossible for them to know if they are getting the best price.
Levitt called for the outright abolition of Rule 390, as well as other barriers to competition between markets. He also pushed for better price disclosure in other areas such as options markets.
There has been notable progress in making options trading more competitive, he said, cutting spreads by between 22 percent and 44 percent since the options markets opened up to each others listings.
But he encouraged the options markets to "promptly put in place linkages to encourage the best possible execution of customer orders." Because options markets are not at the moment linked to provide best execution, a participant on one has no guarantee there isn't a better price on another.
Likewise, in a question and answer session, Levitt said he feared retail investors trading after hours "don't realize the price they get after-hours may not be the best price." For now the after-hours trading on each ECN is separate, with one stock potentially trading on one ECN at a radically different price from another. ECNs have announced plans to link their after-hours quotes.
But Levitt said he thinks after-hours trading is overemphasized at the moment. "For retail investors it has limited utility," he said. "I'm skeptical right now and I hope the public is as well." That will improve when the major markets offer it in 2000, he believes.
But he said the SEC did not want to stand in the way of progress, if Levitt advocated renewed discussion of how to shape markets. "Let us not look back at this time as an opportunity not seized," he said.
But even faced with rapid change and issues too numerous for him to address in one speech, he said, there are guiding fundamentals of quality, trust and accountability stay the same.
"Mountains may rise, rivers may change course, new roads may be created. But unless the laws of nature betray us, true north will always remain true north."
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