U.S. equity securities can trade on a variety of structurally diverse markets. For example, they can trade on any one or more of the following markets: the national exchanges (New York Stock Exchange (NYSE) or American Stock Exchange (AMEX)), the five regional exchanges, the over-the-counter market (OTC)/NASDAQ, proprietary or alternative trading systems (PTSs or ATSs), and the foreign markets. Furthermore, over the past two decades the different markets have become increasingly competitive with one another. While the NYSE once unambiguously dominated U.S. secondary market order flow, this is no longer true as a significant share of trading volume has flowed to the other market centers (especially to the regional exchanges and NASDAQ).

Both of these phenomena – structural diversity and greater competition – are largely due to regulatory and technological changes which have occurred over the past twenty years. These changes include the 1975 Amendments to the Securities Exchange Act and the computerization of trading services. Investor demand has also played an important role in the evolving competitive structure of secondary markets:

In spite of the standard economic argument that more competition is always better, however, there is concern about the form that competition among the different market centers has taken. For example, the increasing challenge posed to the dominant exchanges (like the NYSE) by other market centers has raised concerns about excessive order flow fragmentation and its implications for liquidity and efficiency. Part of the concern stems from the nature of the regulatory system. In particular, some commentators claim that the regulatory centerpiece of U.S. secondary markets, the National Market System (NMS), has led to more fragmentation of order flow than is desirable from the standpoint of economic efficiency. Other policy concerns focus on dubious practices that have emerged alongside the increasing contestability of order flow. A case in point is payment for order flow (POF). POF, it is argued, reduces if not wholly eliminates investors’ choice over where their trades will take place. Thus, the argument runs, increased competition for order flow has not led to a correspondent increase in investor choice, contrary to basic economic theory.

Market transparency raises additional policy concerns. The debate over market transparency involves the question of optimal transparency rules in light of both efficiency and fairness and also in light of the fact that different investors and traders prefer different levels of transparency. Central to the transparency debate is the policy issue whether and to what extent (i.e., for what price) the law should mandate the traditional exchanges to distribute their trade and price information to other market centers. Several commentators argue that transparency rules are unduly burdensome to the traditional exchanges, with negative competitive implications. This paper explores these current problems and others in considerable detail.

I will argue that the current regulatory framework does not adequately address these concerns. In particular, in light of the changes of the last twenty years, the theoretical framework that the current regulatory system is based upon is no longer an appropriate way to view the U.S. secondary trading environment. New theory and evidence call into question the monopoly view of primary exchanges that this system is significantly based upon. Therefore, I propose a fundamentally different approach to the regulation of U.S. secondary trading markets: a genuinely competitive regime that gives issuers and investors a choice over where their shares will trade.

Part II provides a basic overview of the structural diversity of secondary trading markets for U.S. securities. Part III describes the centerpiece of the current regulatory framework, the NMS, in order to set the stage for discussion of current policy concerns in Part IV. Part IV is unique in the sense in that it presents the issues in survey format, relying on both theoretical and empirical findings from the mircostructure literature of financial economics. Then, Part V assesses the current regulatory system’s performance in addressing these issues. In Part VI, I consider new theories of the role of primary exchanges and trading markets in general and, based on these theories, propose a scheme of issuer and investor choice to supplant the current regulatory framework. Finally, Part VII concludes.