Council of Institutional Investors

Market Systems & Structure

End-to-end vote confirmation
As shareholder voting is a core element of corporate governance, shareholders have a keen interest in a reliable, transparent and cost-effective system for voting proxies. Yet the U.S. system of proxy voting is extraordinarily complex and inefficient. Many CII members lack confidence that their shares are always fully and accurately voted and for a decade, a mechanism for confirming that votes were counted as intended has eluded market participants.

In December 2021, a working group co-chaired by the Society for Corporate Governance and CII agreed to provide vote confirmation for 2022 annual shareholder meetings of Fortune 500 companies. Participants included banks, broker-dealers, public companies, tabulators, transfer agents and others in the proxy service community. Broadridge Financial Solutions, Computershare, EQ and Mediant also agreed to provide vote confirmation for all annual meetings for which they tabulate votes, bringing the total covered to more than 2,000 meetings.  While well-intentioned, the mechanism they collaborated on proved cumbersome and time-consuming. Working group participants have committed to providing a more automated mechanism for most shareholder meetings in time for the 2024 proxy season.

Stock exchange operations and governance
CII members and other institutional investors depend on effective market regulation. Long before the creation of a securities market regulator in the United States, stock exchanges were the leading guardians of investor protection. But that is no longer the case. The exchanges have morphed from nonprofit gatekeepers to for-profit entities that compete for primary listings and seek to monetize trading data that is critical to high-functioning capital markets. CII is concerned that the exchanges, rather than upholding high-quality listing standards, are far too frequently engaged in a global race to the bottom.

Payment for Order Flow
For-profit pressure has also intensified arrangements with brokers to attract order flow. Payment for order flow is generally regarded as the system whereby market makers such as Citadel Securities pay retail brokers to send investors’ orders to particular market makers’ platforms. This creates challenges for brokers with a responsibility to deliver “best execution” for their clients. The SEC reports that investors annually lose an estimated $1.5 billion as a result of their trade orders being segmented and isolated from competition.
On Dec. 14, 2022, the SEC approved a proposed rule that would require broker-dealers that provide or receive payment for order flow to report on their compliance with a proposed best execution standard established by the commission.

Under that standard, in any transaction for, or with, a customer or a customer of another broker-dealer, a broker-dealer would be required “to use reasonable diligence to ascertain the best market for the security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.”

The proposed rule also would require broker-dealers to establish, maintain, and enforce written policies and procedures addressing how they will comply with the SEC’s standard and how they will determine the best market and make routing or execution decisions for customer orders. They also would be required to review at least quarterly the execution quality of their customer transactions; compare it with the execution quality that might have been obtained from other markets; revise accordingly their best execution policies and procedures, including order handling practices; and document the results of the review.

 Annual reviews of best execution policies and procedures as well as information about order handling practices also would be required. Broker-dealers would have to document these reviews and prepare and present written reports detailing the reviews’ results to their boards.

CII had supported an SEC pilot program to shed light on the degree to which certain rebates that exchanges paid to brokers encourage them to send trade orders to exchanges that pay favorable rebates rather than to those that offer the best results for investors. The exchanges successfully sued the SEC in 2020 and halted the study.

Quality of Trade Executions
Also on December 14, the SEC proposed enhancements to monthly disclosures available to investors to assess the quality of trade execution for stocks listed on national exchanges. These disclosures are known as Section 605 reports. The amendments are meant to strengthen investors’ ability to compare how well various “market centers” are executing trades. They would expand the scope of entities subject to disclosure; jettison current exclusions of certain order types and sizes; update order type categories and order size categories reported; overhaul time-to-execution categories; require changes to how realized spreads and price improvement statistics are reported; and require a summary report.

In response to an invitation to comment on the SEC’s semiannual regulatory agenda, CII sent the commission a letter Sept. 7, 2022, listing the topics that it hoped the agency would prioritize in its rulemakings.  In that letter, CII urged the SEC to issue a proposed rule that includes provisions addressing best execution and stock exchange rebates. It asked the commission to consider proposing a new best execution rule with provisions that allow the commission to enforce a standard under which each investor is entitled to receive the best execution of their orders on an order-by-order basis. The letter also requested that the SEC propose that stock exchange rebate fee schedules be structured so that the total rebate benefit received is more transparent and investors can understand the amount of rebate relating to their order at the time of a trade execution. For background, read more here.

In the wake of the “meme stock” trading frenzy that roiled the U.S. equities market in January 2021, CII’s Research and Education Fund (CII-REF) published a market structure brief that explained certain policy debates surrounding the meme-stock frenzy including payment for order flow, trade settlement latency, as well as short position transparency.