Six steps to restore investor confidence

These are not easy times for nervous equity investors. The May 2010 Flash Crash, the Facebook initial public offering and the trading debacle at Knight Capital Group last summer are just three examples that offer little reassurance that US equity markets are a safe place to trade or invest.

While this year has brought early stirrings of renewed interest in US equities, over the past four years investors have voted with their feet, pulling more than half a trillion dollars from actively managed US equity mutual funds, according to the Investment Company Institute.

Despite this, US equity markets remain among the most robust and transparent, leading the world in capital formation in 2012 even in the face of a weak global economy.

It is clear that investors need to be reassured, but not at the cost of disturbing the progress that has been made over the past decade in terms of lower trading costs and more available liquidity.

We believe six key initiatives, some of them already much discussed in market structure circles, would go a long way toward restoring investor confidence:

– Consolidated Audit Trail (CAT)

At present, regulators do not have a holistic means of monitoring US equity market activity across all execution venues. If implemented properly and cost effectively, a CAT would provide the two main regulatory bodies, the Securities and Exchange Commission and the Commodity Futures Trading Commission, with an invaluable tool to police bad actors and root out predatory strategies.

– Uniform Market-Wide Circuit Breakers and the Limit-Up Limit-Down Plan

Harmonising these important safeguards across all market centres would eliminate most erroneous trades and, on a broader scale, would likely prevent a market-wide disruption of “flash crash” proportions.

– Excessive Message Traffic Fees

The explosion of message traffic, caused in part by the growth of high-frequency trading, has burdened brokers and investors alike, acting as a de facto tax on the marketplace. These costs should be borne by high-frequency traders who create excessive quote traffic without executing order flow. This could take the form of a market-wide message data fee for traders who have an extremely low ratio of order submissions to executions, similar to the excessive message fee programs that were proposed by Nasdaq OMX and Direct Edge last year.

Level Playing Field for Market Data

Market data should be distributed to all market participants equally; special data feeds should not form the basis of high-frequency trading strategies. Where speed is concerned, it is clear that the law of diminishing returns must be applied to further dramatic shifts in the foundations of our equity marketplace. Microseconds versus milliseconds do not matter to mutual funds or retail investors, and nor should they.

Kill Switches

While it is crucial for broker-dealers to have their own operational and technological safeguards, the market-level protection of a kill switch would likely reduce the harm a rogue program could cause to other market participants.

Facebook

The SEC and Finra must act on the Nasdaq Facebook compensation proposal. There are real investor protections that need to be upheld by regulators that are getting lost in the debate between brokers and the exchanges around limitations of liability. Analogous to the delay in government aid to victims of Hurricane Sandy, compensation for Facebook IPO investors is being held captive in this broader debate, when it should be separated from the issue at hand.

These six measures would give the investing public the protections they need to invest confidently in the world’s strongest and most resilient market while still deriving all of the cost savings and liquidity benefits which have been achieved over the past decade.

The old saying about the perfect being the enemy of the good applies here: we urge regulators to take incremental steps toward improving market quality rather than waiting to enact a broad slate of changes at some unspecified future time. We are steadfast in our belief that US equity markets are on a firm footing, but it remains to be seen how long it will take for Wall Street to regain Main Street’s confidence.

Bob Gasser is chief executive of ITG, an institutional agency broker based in New York