What's going on moon gang, the interview you're about to listen to is with professor j.w varup. Now obviously he's a professor, but on top of that he happens to be a lawyer who is heavily involved in the world of market regulation, which means that he has the unique ability to share with all of us. What in the world is going on. But from a legal perspective, throughout the interview we discussed the contradictory nature of payment for order flow, the high concentration of power in few market makers.

He shares his insights and opinions of what's going on with the sec and finra, and we even talk about some crypto regulations. All in all, it was super insightful and it sounds like the year 2022 is going to be a year of fireworks as it relates to market regulation, and i really hope that you enjoy hello, professor variate. Thank you so much for taking the time to join me today to join the ape community. How are you doing good good to be here? Man, thanks for you thanks for having me here i'll start you off with uh an easy question when i was doing my research on you, it seems as if it takes a small force for you to print out your resume.

I'm not sure if you've run into that issue before, but a lawyer, a professor, you are on the what is it the investor advisory committee to the sec, the former chief? What is economist and senior council to the house financial services committee? The list goes on and on and on so with that being said, could you give us just a like a little preview of your background and why we're here, like you're, definitely defined as the person who's in the thick of it when it comes to market regulation? Uh, so could you just give us a little like, i guess, per view, a little snapshot of your history, yeah sure man, thanks uh, you know somebody once told me: you'll, never embarrass the professor by asking them to talk about themselves, their work, um, so uh. You know people have careers they're, either moles or foxes. Moles specialize. The fox does a little bit everything i'm definitely a fox.

I do a little bit everything man i uh. I teach at george mason law school. I teach securities law, corporate law, banking law and accounting too my forensic accountant. Sometimes i help people on the side with forensic accounting issues find the bad guy.

That kind of thing and some economics as well and i've, done some economics work for house financial services and sit on some advisory committees for the sec and for fasbi that makes accounting standards. So i like to give advice i like to have a lot of opinions, and why we're here is. My latest focus is on two things: really market structure, existing market structure. Is it fair and my argument is it's not because of pf and you've done some great stuff on fifa so far, your show monday was great man um and then the future.

What does the future hold for market structure and how crypto world digital asset world's going to upend everything and that's a good thing, um and and some of the frictions in current regulation that are slowing that revolution down um. So here to talk about all that anything else, you're definitely defined as the person who's going to be in the thick of it. With this regulation, uh very, very exciting, i'm sure there's many quote: unquote apes, who are excited to hear your particular input because with it we've been discussing it from like some technical perspectives, some short selling perspectives, but with you it's definitely much more of the regulatory lobbying Political, so i think this will give an interesting angle that could hopefully open some eyes of people. So let's kick it off with literally news that just dropped a couple hours ago.

It was reported by bloomberg that the department of justice is officially looking into hedge funds and related research firms and some potential in sexual relationships between the two that might not all be above board. I guess you have any like just knee-jerk reaction to that. Any inside commentary of basically these research firms who i'm assuming they're going to be referring to these, like short selling firms and their connections with hedge funds and more of a general sense like it's just abusive, shorting yeah. Well, you know start from the first principle that shorting is generally good for the market.

Short selling is good short selling provides liquidity; it provides a match for a trade for a long trader that wants it. Uh short selling allows the revenue for some of these platforms that are able to provide zero commission trading. They make their revenue off of their short sale lending. So, generally speaking, good practice, i like it now fraud's a different thing.

If there's fraud going on that's different and that's always been the sec's position too, that they've always said well, if there's fraud in in short sales and and i think, probably managers over a legit every time, there's a short attack. The managers say: oh no, it must be fraudulent. Our company is great, our company's always terrific. Every manager thinks that right.

So there's probably some been some historically some some uh, some embellishment from the management side on that. But at the same time, we know that there's some crooked practices going on in a subset of short sellers, too uh, the sec hasn't hasn't ever been able to really catch them. The fact that the doj is on top of this tells me something it tells me. You know.

Scc often refers things to doj and doj says no. We don't have time. We got a million things to do here. We we can't do every securities law case.

You want you know the fact that doj's willing to take this tells me that there's something there um, i haven't read it. It just dropped this morning. So i haven't read the complaint yet, but there's something there and if there's fraud going on, if they're, making fraudulent claims to the regulator with the so-called whistleblower claim trying to help a short position and the underlying facts are not true and they know it. Um.

That's fraud uh if they uh. If they are um, you know if there are some undisclosed conflicts of interest with analysts getting paid to help the shorts uh. That's uh, potentially fraud too, and also a violation of a number of rules for investment. Analysts uh.

So there could be something there and we'll have to watch the case play out yeah. I think, with that. Uh retail, especially starting in january with the insanity of gamestop, have become a little bit more in tune to stories such as this. One of like hang on um, think terms such as like stock bashing and we'll get into this a bit.

But a little bit of media distortion with it of i, i kind of actually agree with you. I believe that certain companies are overvalued. Maybe they have questionable practices they might deserve to they're trading at too much of a premium. They deserve to come down.

I'm not inherently against the practice. It's like. You said when it's being abused with this and like much more of where your expertise is, i would like to talk about payment for overflow, some of the articles that came out and actually a little bit related to the department of justice of potential connections. Of that might be a little suspect of who's getting paid off for what before we get into yours, which was written, i believe in november a recent one in december, who's coming out of a professor from mit titled commission savings and execution quality for retail trades.

It was pretty much arguing that payment for order flow is a positive thing, high quality of execution and it's saving people money and on the surface level. I've heard this many many times, especially from market makers who are making money off of it. But what i find interesting is on page one of it. They do disclose that they have a financial relationship with robin hood.

It's right there page one clears day, that's true! How is that possible like? Can i just? Can i just go pay for my own lobbying. My own, like reports and get that out there and then everyone's like okay yeah. This seems above board like now like you might have to walk me through it hold my hand. I am just a dumb ape, but isn't that, like an obvious conflict of interest like of when you're paying for research, that's positive to you hasn't this previously happened in like the tobacco industry, when the tobacco industry paid for their own positive reports like i just don't Get it well, i'm i'm less worried about it than you uh matt.

I i um they did disclose it um and uh. Look the paper. Look at it! It's not an academic paper. It's not intended to be published in academic journal.

It's very short for a finance paper. I have a lot of respect for sp cathari he's a great guy. He was chief economist at the sec for a while. He went there, but the the paper is good for what it claims to do.

The qualifications raised in the paper or make it less relevant for the discussion right, so the paper says like hey, we measure against the nbbo, that's kind of all. We've got right now. Well, that's an incredibly flawed metric to measure against and part of the whole discussion here is the fact that wholesale brokers like citadel, can manipulate the nbvo. They can manipulate the the yardstick used to measure their own effectiveness uh by deciding which traits to route out to nbo versus those that they internalize, essentially so talking about that national best bet and offer just to clarify for everyone who might have not heard that.

It's just the that's what it is, the mbbo, that's the measuring stick and i actually have a quote from you related to this measuring execution. Quality against nbbo is like measuring your t-ball performance against your grandma's comments. You were the best one on the team. Dear.

So that's a little bit a little bit of a loaded comment there. So, are we thinking that these market makers, the ceos of these companies, are they just getting on the pat of the back from their grandmas, saying, hey, you're, doing great when in reality, we all just kind of know, they're playing t-ball and they're, not as good as Like what's being said there, i i'd like to dive into that and, like obviously i'm being a little bit facetious, but in general, can we get into a little bit more of the detail of why that yard? Stick the measurement, and even gary gensler has said this himself. The measurement is antiquated. He said that he said that this year.

So can you go into the detail of why, when these apes are sitting around for the holidays this year, arguing with their family members of how they need to be looking into this? Can you give us a little bit more detail on like specifically why this is a bad measurement, rubric yeah? So it's um? First of all, it's there's a there's. A wholesale broker choice here, as trades are coming in, we get to decide. Do we route out to the nb to to a lit exchange where this will be reflected on the nbo, or do we keep it internally and and match it internally on a dark platform, our own internal matching engine, where uh it won't be reflected on the nbbo That uh, an algo can help you use that choice to to uh manipulate the nbbo to make it seem like you're, giving better execution than you are, especially when you know some of these i mean citadel's got uh patented technology. They have a patent on algorithmic processes that help them to avoid uh toxic traits toxic flow.

They call it um so that that's that's uh, that's! That is a system that's not designed to give best execution on an order by order basis, even though the wholesale broker has a duty of best execution on an order by order basis, the sec, regs and fender eggs, as they exist now say, look you can't necessarily Always measure best execution obligations against the mbbo but effectively that's what most people do and finra says. Well, we don't really have a better metric right now, so we're not going to bring many actions uh as long as you're, you know executing better than nbbo um. So i think it's due for a whole scale revamp. I think we're going to see more change in the next year in market structure than we've seen since 1975.

wow - and i know some of this - you did touch on and i'm sure you wanted to touch on. Quite a bit more in your write-up in november, robin hood's threat to sue the sec over broker. Inducement regulation unlikely to succeed, so we are now kind of seeing this get into the world of politics. I guess it always inherently was because we know with the gamestop report with gendler and his comments.

We even see some senators, i believe pat toomey was saying he wants to present a bill where you can't pay ban payment for order flow, and i know on that particular one. You just didn't really agree with them, because you think it and please correct me if i'm wrong - i'm not trying to put words in your mouth, that it is detrimental to our overall system. So i guess that paper and i'll post it below for anyone who's interested. Could you give us some of the key highlights because uh there are some things i want to go over, that i found like kind of that particularly jumped out to me yeah well um, so the uh, the general counsel, robin hood uh, said that he would sue In the event, uh the sec banned payment for order flow, because robin hood makes um most of their profit, at least on the equity platform, from payment for order flow um.

So i said: okay, you know you you uh. Now i've known i've known the general counsel, a long time and he's actually a friend of mine, so we've been friends for about 12 years now i i hope he. He still thinks of me that way too, and i gave him a heads up. The paper was coming, i respect him, but i said all right you're going to make a big claim, i'm i'm going to bring the other side of the debate uh in a paper, and i sent him the paper and i'd be glad to get any comments from The folks at robin hood's team and their team's grown a lot in the last couple years.

They've got a lot of smart lawyers over there and i'm glad to hear what they think um but um. I think that threat is an empty threat. I've seen the sec get sued before adopting new rules, especially post dodd-frank, in kind of a hasty way. I've seen them lose i've seen why they lost, and in this paper i do a a line by line analysis of the requirements in the in in the law.

For what the sec has to do and has to prove the economic analysis, it has to conduct when it adopts a new rule, and i look at that. I compare it to the cases where the sec is lost or the sec has won in the past, and i say my verdict is ultimately, if you bring a suit you're gon na lose you're gon na fall flat on your face man, and if robin hood has A better argument: hey bring it man, let's i'd love, to see the paper that says a reply to jw varette, i'd, love that and we'll get a little we'll get a little debate going. I'm sure i guess they probably don't want to do that, because if they really plan to suit they don't want to give away their best arguments right now, because the sec can kind of adapt in the in the rule that it puts out uh. So they're probably not going to respond on paper, but i'd love for them to i'd love to get the debate going with those guys.

I think in a particularly a way. Maybe it was a weak jab against you, but you had that one in november and then the one from an mit professor, in with, like i guess in conjunction with other professors, came out in december. So i wonder if that was like almost a little subtle hit back at you of like why we think this is good and all that, but overall, i think they had it planned. They had it planned and they hope it's going to be used in the in the by the sec, because the one of the lead authors was was recently chief economist at the sec uh.

But look it's a good paper for for what it's qualified to say. But it's just those qualifications make it kind of irrelevant for the regular for the regulation. It would be my point i just out of all the insanity over the past year. I find myself particularly grateful that i am not a member of robin hood's pr team.

It seems like it was probably one of the most difficult jobs of the year at one point in january they're saying vlad ten of he was on with cnbc and he was saying no liquidity issue, everything's perfectly fine, and then the report's coming out and the day Before there's internal messages, saying definitely a liquidity problem, and then you fast forward a little bit gensler in may of this year. He was saying that robin hood explicitly went out of its way to accept higher payment for order flow in return for worse quality execution. This is coming from the sec chairman and he said it was to such an extent that it actually might have overwhelmed any of the the fact that it was zero commission. You might have just been better off on a commission one and it's weird, because when you sum this all up, it seems like they are the antithesis of the name of their platform.

The mythological story - and i know you have some thoughts like particularly on the symbolism of robin hood, uh yeah, you know in the story. The sheriff of nottingham is the one who collects the taxes um, and this model is one in which i mean. Let's be honest here: uh their their business model is one where they collect rents, um, where they they they share, rents in the form of payment for order flows shared back with them from the wholesale brokers that are the ultimate kind of collective rent um. I don't want to go too far into the analogy, but uh no i've had some problems with robin hood's business model for a long time - and you know it makes me sad because i i um i was always a big believer in the in the ability of Digital engagement at based, iphone, app based, engagement, um or or you know, whatever or android app-based engagement uh in in stock trading, and i even did a paper about six years ago - called uberized corporate law, where i kind of predicted like eventually it's going to be all App-Based trading, all the time and people said: that's crazy.

What does that even mean and it's coming to pass, but it's coming to pass in a way that i didn't anticipate um uh, some of it good, but in the robin hood business model, i think ultimately bad for investors. But there are other app based platforms that i think are doing a better job of being more open, more transparent, um and, and so maybe they'll kind of take over the new regime. I think that'll be that'll, be better for everybody. Now, i'm not particularly sure of the one you're referring to, but i was reading a very interesting, i believe, like medium blog posts, uh from public, which is another brokerage that previously to be completely transparent, yeah, it did use payment for order flow, but earlier this year It it said almost like we don't want to use it, we don't think it's good for the market and they just came out with an entire, very cool breakdown, super transparent of how they have not been doing payment for overflow and 70 to 75 of their trades.

Are getting sent directly to a lid exchange and they're, actually getting better execution, which is astounding? That is absolutely astounding, and this commentary that we're hearing, particularly from market makers and whoever is protecting market makers saying no? No. This is better like this is the best traders have ever had it, but then you have this one who's being successful in a regime where it's kind of set up against them and i'm not too much sure how familiar you are with trade at over in canada. There was it's anti-payment for order flow, but i believe their metrics are about 90, go on a lid exchange and the only time it doesn't is, if there's a better a material like improvement in price and right there public, it seems to be similar, 75 linen exchange And the other 25 only going off if you can get a better price is, is that a model you're supportive of like do you like it? Do you think that could be improved, or am i completely missing something here? No, i mean i i um. I didn't know much about public.

Before i wrote the paper i had. I had seen their stance that they were um, not taking payment for order flow anymore, and i i liked it. I agreed with it uh. I thought it was principled um, but since i published since i put this paper out, they actually reached out to me and we're going to we're going to talk next week.

They said we read the paper, we love it. We'd love to talk to you um. So i'm actually going to meet them for the first time full disclosure next week to talk about the paper and talk about this effort. Um, i hadn't i hadn't um.

I i haven't talked with the folks in in canada, at trade at but uh they sound like they're. On the same page too, i think this is the future and - and i wrote this paper because i want to be part of uh and look i'm defending the sec. That's a weird position for me to be in you: i'm a critic of the sec, especially on crypto. I'm a bit, i'm the biggest critic the sec has had, except maybe john deaton who's, been doing some great work on this but uh, but i'm defending the sec.

Here because i think they're doing the right thing and i want to be part of the solution um, so that's what this paper is all about, so with that specifically for something for if we were to give a sound bite to people payment for order flow. Obviously you are outspokenly against it. Can you give us not only your reasoning behind like why is payment for order flow, bad, like what's its downfalls, but also on top of that? We hear it a lot. Even youtubers, like me, are like bad bad, bad.

Let's get rid of it, what do you see the solution? What do you see the environment to look like? That's actually an improvement that the sec or finra all those people can actually like. I guess employ in a certain sense that we can live under, and everyone or the market be a little bit of a stronger, less fragile market system. Um yeah the problem with paying for order flow is: it represents an inherent conflict of interest to the broker's duty of best execution, a duty of best execution. That's been described in the law in legal cases as a fiduciary duty.

That's the highest form of obligation in the law. It's an inherent conflict of interest, it's effectively a kickback, um and uh, and at the retail level you retail traders, don't have the tools to assess the effect of p5 on the quality of their execution. The whole system is designed uh to be opaque uh by design um, so i think it has to be eliminated. At the very least i mean you can start by just saying look.

What's the big argument for fifa, it provides liquidity. Okay, let's ban p5 for the 500 most liquid stocks right there, that i i don't see what robinhood's argument could be to that other than it cuts in our profit margins. We really don't like it right um, but i think he got abandoned totally and that'll bring us to more lit execution. It's not to say unlit is an illegitimate venue, but but i think we need more lit to get uh the price discovery, uh and and quality of execution that we used to have um.

And i think it doesn't mean an end to zero commissions, because i think that there are platforms that if public can do it and if fidelity can do it um on everything other than options for fidelity um, then anybody can do it. I mean it's it's uh. I i i think that it doesn't mean an end to zero commissions. I think that the the congressman you know kind of have been told that by romney's pr team, but i don't think it's true so for you the solution, obviously you're against it, and it seems like it's just this conflict of interest like, and i would agree with That because rahman said, hey, hey, we'll take piss-poor quality execution in return for more money like they're, trying to improve their own bottom line, opposed to really caring about their clients.

So i 100 agree with it and i'm sure if we really looked into - and we had unlimited time - i'm sure we could discuss even more really conflicts of interest there. So you're you're kind of campaigning that the solution is, let's just ban it and then see where the chips fall. And if that's right, like i'm, assuming a lot more trades, will just be done on a lid exchange and maybe we'll get a lot more midpoint training and have more robust price discovery. More probably even more efficiency and liquidity.

They would argue if everyone is fighting for that overflow in the equal sense, because right now, if you have one person paying for it, no one's fighting for that order flow, whether you're talking dark, pools, market, internalizers or lit exchanges, if one's paying for it. There's no competition for order flow, yeah and that's the competition angle is another one. I think the sec needs to take a look at, and i talk about my paper. The sec has a role under the statute as an anti-trust regulator as a as a anti-monopoly regulator, and the sec hasn't really used that toolkit very much, and i think this is a this - is a chance for them to pull it out.

Definitely that's interesting. Um kind of going off that and maybe a little bit more of a general sense - and this is probably one of the - i have two finra questions for you from your paper, so finra and i found this is the first time i actually read about it was In yours - and i implore all of you to check it out um if i read this right, finra is a self-regulatory organization. I believe somehow, between its members takes in over a billion dollars a year and one of its rules is that i, i guess for brokers they're only allowed to spend a hundred dollars. So there's no conflict of interest.

They don't want this gifting to get out of hand, so if you can only do a hundred dollars from brokers to whomever, how is that different, how is the sec or finra or doj not come down on the fact that from market makers to brokers there's billions Of dollars from exchanges to brokers, there's even there's more money, also with rebates, so i'm confused - maybe i'm too dumb to get it. But if there's a hundred dollar gift cap, i'm seeing a ton of payment, i'm seeing a ton of inducement. Why is that a little caveat that everyone's just kind of like being blind and they're like oh yeah? No, no. We don't know anything about that.

It uh yeah, it's it's uh! It's inconsistent, i mean finra, says if you're a broker and you get uh more than a hundred dollar. You can't take more than a hundred dollars from you know. If somebody at nysc wants to take you out to lunch, um don't go anywhere expensive. They can't spend more than a hundred dollars on you right, but in net rebates from them or or in a in a payment for order flow from a wholesale broker.

You can take billions of dollars. Um, it just doesn't make any sense at all. So, like your options are, let's go out to taco bell and also here's billions of dollars in payment for order flow under federal rules. That's a lot! I i'm just picturing all of these business tycoons wall street elitist, like meeting at like chipotle for the these meetings are like all right.

We can afford this meal, but then they're just talking about billions of dollars of business practice, you could own a hundred dollars. You could at least do you know a couple people at red lobster. I think all right, that's awesome! I like it in this community, i'm sure we're all hoping they're, probably out of wendy's, but that that's more of a community thing. My second question with finra, like i said, self-regulatory organization between its members: it's in excess of a billion dollars.

Please correct me if i'm wrong on this, but between the governance and board structure of the people who are like making up that it seems like there's. No rule of the fact that finra who's supposed to be protecting investors, the people who make up compose all these boards - they can be in the industry, and let me go with this train of thought for a second. If you have some people over here, working that are supposed to protect investors, but simultaneously they're working in the industry, who's trying to make money off of investors and they're working at both. Isn't that another conflict of interest - that's another one.

I just don't get well, i mean i i'm a fan of the self-regulatory organization. I think it. It limits some of the excesses of of government agencies um and when you get all the members of industry around the table and when you make sure the board's well represented, you've got some brokers. You've got some dealers, you've got some people who are broker dealers, but maybe mostly they're.

You know running mutual fund complexes um. When you have different interests all around the table, then they can kind of you know kind of match each other and balance out each other and at the end of the day the sec is overarching above this fenrir organization. So i'm a fan of finra um uh. You know i just i, i think they um the rule they have to to to to combat these practices.

Best execution um is not well defined and it just hasn't worked um, and i think it's just time for a ban. I won't blame fenrir for this one. I think the sec just needs to to knuckle up and ban people. They've been thinking about doing it for 40 years, they've always hated people um.

I think it's time to step up to the plate and just uh. Just just just call, you know say: the emperor has no clothes here. This is not fair. This is not best execution, um, don't do it anymore, but do you think i mean i didn't know that they were discussing it for 40 years and it seems like recently.

It's really picking up steam and apparently it has been globally as well abandoned what the uk, australia, canada, the european commission just completely said no to it. But coming back to like the interest - and i get that of on the board, like i'm just wondering if there's someone on the board who's fighting for actual investors interest, because you were saying a myriad of interests, i'm wondering out of all those people how many other People it is it's like. Okay, you have the interest of the banks of the market makers of these lenders of other brokers, i'm wondering if anyone there is actually representing the interests of just joe schmoe. Like me, yeah, i think they're um uh, i'm not as up on the the membership of fenrir board, but i know there have been some pushes in congress to try to open up that board to have a more diverse membership, and that might be a good idea.

Gotcha, so if it's been discussed for 40 years and obviously other countries have already been against it and the commentary from ken griffin at citadel, i believe he was doing a bloomberg talk and he was basically saying: hey payment for order flow is an expense for me. Uh just tell me it's the rules and he was basically saying hey. Tell me what side of the road to drive on i'll drive on so may. I i think he meant it facetiously.

He was just saying: hey i'll play by the rules. Uh doug seafood just had also comments of hey. Fidelity does not accept payment for order flow and they're getting good execution. I believe that was an interview um.

So if we have these two leaders between vertu and citadel securities, who seem to not be saying hey, we need it and a lot of the world's saying, maybe a bad practice who in the world is still fighting for this thing, i i don't get who's the Leftover potential straw man in this argument - that's like just keeping the fight up, i'm i'm confused on that part of it of who is fighting, apparently behind like closed doors and keeping payment for order flow alive. Well, uh the recipients uh of it robin hood, high speed, guys uh. I think the um, those lit exchanges that provide rebates. We haven't talked enough about rebates, uh, but rebates is another type of people that the exchanges do.

So i think nicey nasdaq, uh cme will be interested in this um because it seems like ginseng wants to broke them together. So robin hood nicey nasdaq um. Do we take citadels and virtue's comments at face value? I don't know i don't know uh yeah right um. You want to thank the best of people, but um, you know i they might join the fight as well or be behind the scenes and get trade associations to sue or something like that.

Sometimes that's part of the game uh so we'll have to see. Speaking of is part of the game there um with your connection to politics and there at george mason and everything. Could you shed a little bit light on? Okay, i guess: how does the sec finra actually come up like actually come up with the regulations? How do they get written into law? How does this lobbying work? Is it only lobbying that gets things done because i think, like i said, the average retail trader? That's one thing that we really just don't know about all i'm seeing is headlines of how, from this year to last year, robin hood has how many of her times multiplied its lobbying efforts and it seems like a a pay to play. Structure almost for people are paying for what they want to see, but potentially not the best for humanity um.

I think so far what they've gotten with their investment and - and i got to be careful here - because i know the people that they've hired - i probably know - probably friends - with a half dozen people - that they've hired so they're good people, they're smart people, they're good at What they do, the best they do. Um look on the hill on capitol hill uh financial services legislation isn't moving right now, it hasn't really been moving much at all, since dodd-frank was adopted. Um. I don't see anything moving on this issue at all in the near future, so the ball's in gibson's court they've been successful, getting some republican members to jump to their cause.

They've linked p5 to zero commission, since and and with the talking pointed ban, piefo no more zero commissions. Of course we know. That's not true. If public can do it, if fidelity can do it, it's pretty easy to counter that talking.

Point um but uh it balls into cancer's court and guess was i. If you read the speeches uh, i think that he's got a majority on the commission to do something strong here and uh. So from there it's just a question of how it's designed and whether or not the staffs worry about getting sued and losing when they get sued. That's why i did this paper because that's the last thing i think that could slow them down is this threat of suit from robin hood.

I think ginseng's got a clear path to do everything he wants to do addressing conflicts of interest posed by people. The one hiccup staff might be worried about is, maybe we'll get sued and lose. So that's why i did this paper to show look guys if you do things right in the regulatory process, you're going to win, don't worry about suit at all. That's the point of this paper.

The audience for this is the sec. I want to buckle up the staff to do something, tough and know that you know i've got their back on this one, i'm against them on crypto and we're going to have some tough discussions on crypto. Maybe we'll get to do that late later, but uh, but i got their back on this one and i think they're gon na win uh as long as they do everything right now. The regulatory process sec will do first, the rule proposal right.

Here's our proposed rule some initial uh contours for what we plan to do and also a lot of questions. We want to ask the market about what they think. Then there's a comment period and that's where your members are going to be important, where your listeners going to be important. They need to comment into this if they, if they see the points that you and i are making here, they need to comment into the process and then there'll be maybe half a year or so of comment.

Letters coming in um and then the sec is gon na. Do a final rule. Uh that'll that'll be implemented, uh, maybe end of next year uh and i think we're gon na see some kind of a ban on p5. I think that's just unavoidable at this point.

Maybe it'll be a partial ban, but i hope it's a full ban and then there'll be, i think, probably, litigation and i think i've got the roadmap for how to defend the sec. So so you know over under my friends and i have an over under how many times am i going to get cited in litigation? I hope it's a lot. That's a lot of plan anyway. So is this one of those scenarios that the wheels of justice just turn slowly and these types of it's just huge structural changes that might take time because i'm thinking about when the gamestop report came out, i believe in mid-october.

There was also a companion piece and then my first thought was are: is there infighting or do you think? Maybe there isn't infighting at the sec they're just trying to best structure themselves. So when they really go like it's going to be a successful effort, yeah, i think it it uh they've been slow um. You know it's. It's uh also important.

You may want to link to this um. The the sec has a new uh director of the division of trading and markets. Uh and uh. You can link to his paper.

He's got a paper. Uh he's a finance professor, so he's a colleague of sp kathari. He wrote the pro-p5 papers all right, so they're in the same finance department at mit he's got a paper. I call uh uh titled uh back running, so it's a sort of a take on the front running idea, which is a part of what you know.

Pfoff promotes in in some instances latency or kind of stuff, and he says well look at look at back running. Look at the ability to take uh uh linked uh. You know touch points that the algos do that the high speed algos guys could do uh to use to get ahead of subsequent orders that were related to the initial orders, uh that they only learned about, because the limit orders that weren't really designed to be executed. They were just designed as kind of intel gathering limit orders that were put on the exchanges.

Uh uh, you know, exchange-wide um he's got a great paper about that and he seems like a guy that gets it. So i think, that's a that's a move in the direction of a strong approach to before the fact that they uh his name is professor zang and um. I think he's going to be uh. I think i think maybe they were waiting for him to come on board, so his first date is december.

6Th uh i'll definitely check that out. Yeah we'll get that link for sure um before we move on to crypto regulation. On that a little bit related to pfoff when we're bringing up market makers, obviously it seems like you're fighting for what you believe to be a safer, more robust system which right now wouldn't be classified as anti-piff. I personally believe that, right now, the extreme amount of power concentration in too few of liquidity providers, aka market makers, wholesalers, retail internalizers - whatever you want to call them, i think that's another thing that is inherently increasing the fragility of the system, for example.

Not too long ago, when citadel decided to dust off its twitter account and start firing off hot tweets again, it was bragging that was the only one that provided liquidity during the insanity of gamestop and at first i get that brag they're like look how good our Business is but then to me when i'm now in my later 20s and i'm always being pitched that the u.s market's the best one ever it's robust, it's strong, everyone should be investing in it, but it doesn't make much sense to me when there's when things are Getting a little bit more tense and there's tension in the system that we only have one player who's still providing liquidity that doesn't seem reasonable to me. It just doesn't seem safe. It seems like this. Safety net is a player rather than a net of players.

Um. I, i guess, do you have any thoughts on that? One yeah and i think it's something the sec needs to look at here. The sec has a mission as a competition regulator and the fact that uh, i think that that practices like pfoff and exchange rebates, um, encourage and contribute to the level of consolidation in the market, particularly the level of consolidation on unlit venues and among whole. These two wholesale brokers - and i think, that's a component of why the sec needs to take action, spread the trading out, move the trading toward more lit venues, not move it, but allow it to move that way.

I think it will naturally move that way. If you take out the distortive effect of peep off and exchange rebates, and the other related issue is the fact that if you look at exchange rebates, the net is so top-heavy and price discriminatory. Those exchange rebates are uh designed so they're specific individual by individuals, price discrimination, kind of like what disney does for uh admission right. They they uh have the top fee, but they try to make sure that everybody pays exactly their price point, so they charge different prices to people based on how they can reach them with different sized coupons - and you know so they start with the massive markup.

If you just show up at the park right, they try to hit you at the right top of your price point so that there's no consumer surplus. It's all producer surplus um, that's price discrimination, not necessarily illegal, but certainly a competition issue to look at as a competition regulator and the level of price discrimination we see on the exchange tier exchange, rebate, tiers um is an issue that you know. I think they need to take out the old anti-trust toolkit and uh apply it here and and um. Hopefully they will yeah.

I i definitely hope so too um with all that being said, when i was doing my research on you uh a lot of your commentary. Public commentary has been anti-payment for order flow and very in-depth there, but it seems, like you, have this whole other side, where you're very much following crypto regulation. In fact, you were just kind of live tweeting some stuff and i think at first it might be helpful for the audience. If we really get into you have commentary on the howie test when it's coming to digital assets, and also you were referring to safe harbor, as that also relates to digital assets.

So i was hoping general sense. What are your thoughts on crypto regulation? Is the government gon na be supportive of us, not supportive of us and all those other things that i just listed too they're important, they're incredibly important, and i think too few of people have even heard those terms sure yeah. So, let's start with the howie test. This is the test with the sec uh the sec.

If the sec says you're a security, then you have to register with the sec uh, there's a long list of things in the statute that that congress adopted in 1933 and another one in 1934 when they created the sec, created the securities laws long list of things That are deemed to be security, stocks and bonds and all kinds of things like that some 30 things so we're applying something from 1933 1934 to yeah right. That's right, uh, yeah, uh, so that's its own problem within that statute. There's one idea of an investment contract kind of a catch-all and according in sec versus howie defined. What investment contract means that it was a four-part test, an investment of money with the expectation of profit solely from the efforts of a third party promoter or third party.

Three or four port tests, but depending on how you cut it, an investment of money in a common enterprise with an expectation of profit solely from the efforts of a promoter or a third party um. Usually, it's the it's, the pro expectation of profits from the efforts of others that the sec most focuses on to define you as an investment contract. Therefore security. Therefore, you must register with the sec.

Okay, so uh it's an old test, it's an old test and the court in the 1940s that developed it was referring back to state securities laws that predated the sec from the 1900s 1910s okay. So this is a 100 year old test we're using to decide if some a project needs to register with the sec. It makes sense you're right right, exactly um, it's it doesn't apply it does. It doesn't work in a number of ways.

I think eventually somebody's going to challenge it when and then the sec is going to figure out what to do right. So, first of all, this supreme court case in 1940 springford uses words very carefully supreme court, says solely from the efforts of others. It's an expectation of profit to come solely from the efforts they're going after ripple xrp on the basis of a claim that um, you know ripple, does some market making and does some custodial activities and does some kind of curating of the ledger right, but mostly uh. Those efforts are not ripple uh.

The efforts that create profit don't come from ripple. A literal reading of the supreme court's test that laid out would not apply the ripple xrp um, so i think, there's some problems with this test. I would design something differently and i think if the the sec is very careful about the cases it brings, it doesn't bring many cases because it's worried it's gon na lose um. I think this cat and mouse game doesn't do anybody any benefit investors or the sec? I think there are some projects too, that say: okay, we would love to come in and register as a security.

Oh right, interesting. What there was this great quote: uh from the head of policy for the chamber of digital commerce last week when she was sitting and um uh listening to uh the current chairman and the prior chairman say you know just come in and register talk to us. It'll be fine and she tweeted yeah register is what right. So securities laws are all designed around.

There's a stock in an equity interest in a firm, that's run by a board. Okay, that's how we used to do things, but that's not most of these especially defy properly described d5 projects. That's not how they work. There's no board, there's no firm right, uh! It's it's uh! Sometimes it's pure cryptocurrency! It's just pure mind something that relates to a maybe a right to data or something but there's no firm.

There's no people working on the thing that you have an interest in their profits um. So how do you comply with things like the proxy voting requirements? There? There's no proxy voting, we don't need proxies to to exercise governance rights and the in the uh that come with the token there's no proxy process. We don't need that. That's the whole point of um the way these things engage on a peer-to-peer basis.

They they um. They don't need proxy voting that we send out in the mail or something um, so i mean it's. The reality is is um. The sec is like.

I often think of it. Like imagine a conversation in the 1910s, where ford has the model t and they go to the horsey horse and buggy regulator, and they say: okay um. We want to get this thing on the road. The horsey horse and buggy regulator is like.

Well, you need a horse and buggy license to get this thing on the road and that's clearly a buggy, because it's got uh, it's got four wheels and it's it moves on the efforts of of someone other than the driver and you're like wait. A minute uh. We don't have a horse, how do we comply with the horse and buggy laws? There's all these laws about? Have you been to the vet? Has the has the shoes been replaced on the horse? We have a combustible engine, it doesn't go to the vet, it doesn't have horseshoes and the horse and buggy regular is like well i'm sorry, but you fit the definition of horse and buggy and you need a horse and buggy license, and so you got to comply. You got to go to the vet and you're like what i feel like you're, not listening to me.

We don't have a horse, we don't go to the vet. This is the combustion, that's where we are right now now there are more sophisticated conversations than that going on at the staff level, but the staff are going to engage in trying to figure that out and hearings that in congress have been a little better. There was a hearing this week there was less posturing, less kind of peacock posturing than there usually is in congress in congressional hearings. Um.

A lot of democrat members willing to listen republicans are mostly very pro-crypto, which is good um, but a lot of democrat members willing to listen, which was a nice surprise and understand the issues and some very strong pro crypt, though uh there's a congressman from florida. Who's doing a great job on this um, so i have hope i have hope um. The commission itself is gon na have to have a real kind of um kind of a come to jesus moment here, where they realize that they're gon na have to work with this industry. Uh they're gon na have to tailor rules in some ways.

It'll be helpful. If we had some disclosure standards for how to disclose who's, helping to curate the ledger, who's got control of the governance tokens uh. You know how a fork would work if a fork happens or not or needs to happen. That would be great, some standardized disclosure about that - probably working with the subregions organization of crypto experts um.

But you know they're just not there yet, but they're going to have to be there i mean, and it may be the precipitant for that's going to be ripple. Xrp, if the sec loses, of course, that's going to be a real problem for them, but even if they win they'll, be the dog that caught the car they're gon na have to figure out what to do. At that point they can't just make xrp register as a security, because what is what does that financial statement? Look like xrp, give you a right to profits and ripple. So you can't just use ripple's financial statements that doesn't work.

That's that's not gap compliant um. So i feel passionately about this too, and this is one where i think the sec needs to get with the program so with your legal understanding of going what's going on um, if you were a betting man in the ripple sec, one who do you think is Actually, gon na end up winning that well uh, it's gon na depend, there's uh, there's an individual. Is it a question of holding the individuals liable question of determining whether it's a security, so there might be multiple um victories or losses uh. I don't think.

Let me start with i hate to make a prediction: okay, um, but at least i'll say this - i don't think the westies is gon na gon na gon na uh gon na uh win everything i think they'll lose at least one of those motions, interesting um, and Then, in the more general sense with this, and obviously it sounds like the howie test - it's archaic, you're trying to measure a horse and a buggy, but we have a whole new age buggy. So i guess bringing that to the next level. What do you think the solution is there, so it's just like don't apply the howie test and make a new test, or do you think that crypto should not be regulated by the sec at all like? What do you see the solution to be there um? Well, i think the industry's already trying to come up with new solutions - uh industry groups, are kind of trying to come up with a new test. Uh congressman davidson warren davidson's, a big uh proponent of crypto and and he's worked with some.

He referred to a new test in in in uh the hearing uh uh that was held on wednesday um. So i think it has to be a new test and i think folks would like to register if there was a crypto specific regime that they could register. In a digital asset, specific regime, but the sec is going to have to fix a lot of these things. I mean just look simply put everything: corporate governance that the sec does; boards proxy voting; um definitions of control person and what's an underwriter or not.

None of that it fits within d5 or and or dow based governance models. They just don't fit at all. If forget, a square peg in a round hole, you're trying to fit a a toyota into a kid, a square peg on a kid's toy. I mean it just doesn't fit at all man, so you're thinking this upcoming calendar year 2022, depending on whenever you happen to be watching this video uh, you think it's just gon na be regulation, fireworks everywhere, crypto equity markets.

You think 2022 will be remembered as the year of i guess, like regulatory fighting of like who's right who's wrong, just like down in the trenches getting dirty and we'll see who prevails yeah, i think so. Uh we haven't talked about a lot of other rules that are coming down the pike but uh. The sec's regulatory agenda is probably the fullest i've seen in a long time, so there'll be a lot of fights and you know sometimes i'll back the sec when i think they're right, sometimes i'll fight them. When i think they're wrong.

That's just that's just how i do it now. Could you just give us a little bit of a highlight of those other ones coming down the pike of the other regulations that you think will just be. I guess useful for retail traders such as myself to at least be a little bit paying attention to yeah. Well, one of the most contentious fights is going to be over esg environment on social governance.

The sec is doing a rule on climate disclosure um and you know along the spectrum, if you're an energy firm and you want - and you need to disclose the carbon emissions for the last year by your energy producing firm. That's easy. You've already got that information. You've got a team of engineers who know that off the top of their head right.

That's not that's not hard to do versus something called scope: 3 emission scope, 2 or scope 3 emissions. Where you try to look at. Let's say we're not an energy firm and we have to disclose the energy that's being used, the carbon emissions that are being used by our customers as a result of using our prod products, um that becomes kind of onerous and almost impossible for some companies to do.