A retrospective on the unfixing of rates and related deregulation
This article is adapted from the book being prepared to commemorate the WFE’s 50th anniversary. The book is based on a dozen essays, reflecting on transformations of various sorts – trading floor to screen, member cooperative to demutualized company, starting a regulated market from scratch, the value of regulation, the effects of deregulation, etc. The book’s purpose is to examine the various roles exchanges play in public life, and the ways in which they have contributed to the growth of capital markets over these decades. Essays from the WFE’s jubilee book will be featured in Focus, and publication is due to coincide with the October 2010 General Assembly, to be hosted in Paris by NYSE Euronext.
Traditional stock exchanges were membership organizations where stock exchange members dealt with one another on a preferential price basis. Fixed minimum commissions were the glue that held the New York Stock Exchange (NYSE) and other exchanges together, while members of the National Association of Securities Dealers (NASD) dealt with one another at an inside trading price. Commission price regulation similarly was the norm in Canada, Australia, London, Japan, and elsewhere. In addition, NYSE rules required members to bring all of their orders to the NYSE floor for execution, prohibited access to the exchange by non-members, and required member firms to be engaged primarily in the securities business. NYSE member firms could not incorporate or become public companies.
In the late 1960s, however, the fixed minimum commission structure came under pressure in the United States due to the institutionalization of the public securities markets. Although the NYSE resisted the deregulation of commission rates, various rebate practices developed that put pressure on the fixed commission structure and eventually assured its demise. In the mid-1970s, the NYSE finally abolished fixed minimum commission rates. Further deregulation flowed from negotiated commission rates. The Securities and Exchange Commission (SEC) dismantled the prohibitions against off-board trading. Brokerage firms incorporated and many became public Corporations in the years that followed. In time, these public corporations became financial services conglomerates. In the 1990s, a spread fixing scandal ultimately forced the NASD to abandon the one-eighth trading spread convention, and the SEC subsequently mandated trading in decimals rather than fractions.
Canada and Australia followed the United States lead and deregulated commission rates in 1983 and 1984, respectively. In London, the trading markets were similarly deregulated by the 1986 “Big Bang” mandating negotiated commissions and ending the separation of brokers and jobbers. Fixed minimum commissions eventually ended in other trading venues as well, although Japan did not deregulate exchange commission rates until after the Japanese “Big Bang” announced in 1997.
Deregulated commission rates not only changed the organizational structure of securities firms, but also of stock exchanges. Beginning in 1993, stock exchanges demutualized in many countries and became public corporations. Furthermore, stock exchange floors disappeared and electronic communications networks or alternative trading systems (ATS) formed to compete with regulated exchanges.
These changes were precipitated both by developments in the trading markets, especially the growth of institutional trading and technological innovations, and a political preference for competition over regulation. In addition, to compete internationally, once the United States unfixed commissions, other jurisdictions had little choice but to follow suit. The philosophical impetus for a changed view of the role of economic regulation can be traced back to Alfred Kahn, and such deregulation was initiated in industries other than the securities industry. Yet, considerable new regulation of the trading markets accompanied deregulation of the securities industry in the United States in the form of national market system regulation, and in Europe in the form of European Union (EU) directives and regulations. In the United States, the SEC focused on making transaction costs as cheap as possible, but at the same time, limiting the extent of market fragmentation. The Europeans focused on dismantling of protectionism and on the creation of a European securities market as part of the internal market program.
Although the unfixing of commission rates and related deregulation of the trading markets were successful in bringing down the costs of execution, the substitution of a trading culture for an investing culture is troubling to many. Public investors wonder whether securities intermediaries have been looking after their own interests to the detriment of retail investors.
This chapter will describe the unfixing of commission rates and related deregulation of the trading markets in the United States and a number of other countries. It will pose, although not answer, the question of whether this response to institutionalization and computerization of the trading markets has benefited all participants in the public securities markets.
In any event, the broad political consensus favoring deregulation in the securities field probably ended with the financial meltdown of 2008. The SEC and the EU are currently worried about fragmentation and a lack of transparency in securities trading. These concerns were raised in the mid-1970s, but later submerged in the rush to deregulate the trading markets. Whether the private markets of today will be the public regulated markets of tomorrow is a good question. Alternatively, perhaps trading on these ATSs will return to traditional regulated markets—stock exchanges—because of a return to a political philosophy favoring regulation.
Roberta Karmel's biography
Roberta S. Karmel is Centennial Professor of Law and Co-Director of the Center for the Study of International Business Law at Brooklyn Law School.
She was a Commissioner of the Securities and Exchange Commission from 1977-80, a public director of the New York Stock Exchange, Inc. from 1983-89, and a member of the National Adjudicatory Council of the NASDR from 1998-2001. She was engaged in the private practice of law in New York City for over thirty years at Willkie Farr & Gallagher, Rogers & Wells and Kelley Drye & Warren.
She received a B.A. cum laude from Radcliffe College in 1959 and an LL.B. cum laude from New York University School of Law in 1962.
Professor Karmel is a Trustee of the Practising Law Institute. She is Co- Chair of the International Coordinating Committee of the Section of Business Law of the American Bar Association and Chair of the AALS Section on Securities Regulation. She is a member of the Advisory Committee on capital markets law to Unidroit, a member of the American Law Institute, a Fellow of the American Bar Foundation, and on the Boards of Advisors of Securities Regulation and Law Report, The Review of Securities and Commodities Regulation, and the World Securities Law Report. She was a Fulbright Scholar in 1991-92.
Professor Karmel is the author of over 50 articles in books and legal journals, and writes a regular column on securities regulation for the New York Law Journal. She is a frequent lecturer on financial regulation. Her book entitled Regulation by Prosecution: The Securities and Exchange Commission vs. Corporate America was published by Simon and Schuster in 1982.