The U.S. Equity Markets: A Plan for Regulatory Reform

Committee on Capital Markets Regulation, 2016

179 Pages Posted: 28 Sep 2020

See all articles by Hal S. Scott

Hal S. Scott

Harvard Law School

John Gulliver

Program on International Financial Systems

Date Written: July 27, 2016


Well-functioning trading markets for stocks are critical to the U.S. economy because they promote the productive allocation of capital. They do so by establishing accurate prices for the shares of publicly traded companies and by enabling investors to efficiently enter and exit their investments. However, in recent years, a lack of understanding of our trading markets has fostered concerns that the markets are not functioning effectively for long-term investors. Some critics have even gone so far as to suggest that the equity markets are “rigged” against long-term investors.

“The US Equity Markets: A Plan for Regulatory Reform” (“the Report”) addresses these concerns in two distinct ways. First, we seek to inform the public and policymakers about the U.S. equity market structure and evaluate its performance for U.S. investors and public companies. Second, we set forth twenty-six recommendations to enhance the performance of our equity markets. We note that the Securities and Exchange Commission (“SEC”) has the authority to implement all of our recommendations except for three that would require legislative change. These three recommendations are noted with an asterisk in the list below.

To inform the public about our trading markets, we have conducted an empirical analysis of U.S. stock orders and executions over the past twenty years. This research allows us to reach conclusions as to how investors and public companies are faring in today’s markets. Overall, we find that our trading markets are performing very well for long-term investors. For example, we find that our markets are highly liquid and that investor transaction costs, as measured by bid-ask spreads, brokerage commissions and price impact, are at record lows. Additionally, instances of extreme volatility have been infrequent and isolated, and can be addressed by our recommendations.

We also explain high frequency trading (“HFT”) strategies and “dark pools” and we review the academic literature on each. With regards to HFT strategies, we believe that they are best understood as modern variants of traditional market making and arbitrage strategies that have always existed in equity markets. These strategies can provide important benefits to markets—market making provides investors with liquidity and arbitrage improves the accuracy of stock prices. Our review of the academic literature on HFT strategies finds that they are generally associated with positive effects on market quality, particularly with respect to liquidity, price efficiency, and volatility.

With regards to orders that are executed in the “dark,” we find that dark orders are often executed at a better price than the best publicly displayed price. However, our review of the academic literature on the relationship between dark trading and market quality is inconclusive. A number of studies find positive effects from dark trading, such as lower transaction costs, while several others find that dark trading can have negative effects, including a reduction in the accuracy of stock prices. In addition, we explain the key rules that govern trading in the U.S. stock market and their policy goals. These rules were last comprehensively revised over a decade ago and since then, our equity markets have dramatically changed. We explain how. Our recommendations to modernize the existing equity market structure rules are based on three underlying themes: (1) Increase transparency; (2) Strengthen resiliency; and (3) Lower transaction costs by enhancing competition. A list dividing our twenty-six recommendations into these three themes is included at the end of this statement.

We hope that dividing our recommendations into these three groups will clarify the order in which policymakers should address our recommendations. Indeed, we strongly suggest that the SEC promptly acts on our recommendations to: (1) Increase transparency and (2) Strengthen resiliency. We believe that the benefits of these reforms to investors and public companies are clear and significant. Furthermore, these reforms should face limited opposition, in part because they do not affect the existing competitive balance between exchanges and broker-dealers.

More specifically, the disclosure rules that apply to our equity markets are severely outdated, as they were implemented in 2000 when stocks primarily traded on the floor of an exchange. Enhanced disclosures by exchanges and “dark pools” would allow brokers to better identify the trading venues with the best prices. This will put more money in the pockets of investors, because brokers retain significant discretion about where they will send and execute a customer’s order. Brokers should also be subject to enhanced disclosure requirements so institutional and retail investors can determine whether their broker is getting the best prices for their orders.

Strengthening the resiliency of U.S. equity markets would also improve investor confidence by reducing the likelihood of events like the May 6, 2010 “flash crash” or the volatility seen on August 24, 2015 (when hundreds of stocks did not open on time, were subject to multiple trading halts after opening and traded at highly volatile prices). Indeed, most of the existing volatility controls are relatively new, and recent events have provided us with the information that we need to enhance them.

Finally, we expect that our recommendations to lower transaction costs by enhancing competition will be our most contentious recommendations. This is because certain of these recommendations are based on the view that stock exchanges have authorities that reduce competition and increase transaction costs for investors. Most notably, exchanges have control over the sources of market data. We therefore recommend that the SEC take incremental steps when possible. The use of pilot programs and independent studies could be especially valuable to ensure that these reforms have a solid analytical basis. Such an approach would promote both the effectiveness of the reforms and the legitimacy of the SEC’s actions.

In conclusion, it is our strong view that now is the time for policymakers to act in the best interest of long-term investors by unleashing the benefits of transparent, resilient and competitive equity markets.

Keywords: regulatory reform, equity markets, capital markets

Suggested Citation

Scott, Hal S. and Gulliver, John, The U.S. Equity Markets: A Plan for Regulatory Reform (July 27, 2016). Committee on Capital Markets Regulation, 2016, Available at SSRN:

Hal S. Scott (Contact Author)

Harvard Law School ( email )

1557 Massachusetts Avenue
Cambridge, MA 02138
United States
617-495-4590 (Phone)
617-495-9593 (Fax)

John Gulliver

Program on International Financial Systems ( email )

134 Mt Auburn St.
Cambridge, MA 02138
United States
02138 (Fax)

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