Lloyd Blankfein. Thomson Reuters

Goldman Sachs filed a letter with the SEC letting it know that it has some deep concerns with the state of how US equity markets operate.

The letter was filed in support of trading venue IEX, which is seeking to become an exchange.

But it also expresses concerns over the prevalance of high-speed trading, potential conflicts of interest at public exchanges, and the dissemination of market data.

IEX― a trading venue made famous by Michael Lewis' "Flash Boys"― filed with the Securities and Exchange Commission in September to become a stock exchange. A heated debate over the merits of the application has followed.

According to Goldman, the debate around the IEX application "presents the Commission with a timely opportunity to address broader market structure issues."

Goldman Sachs has one of the biggest equities sales and trading businesses in the world, ranking second by revenues through the first six months of the year, according to data provider Coalition. In stock trading, it ranked joint first with Morgan Stanley.

The letter said:

The US equities marketplace is one of the most efficient and liquid securities markets in the world. It is a product of constantly evolving regulation and technological innovation. However, this evolution has also generated certain unintended consequences, including more complexity and fragmentation through non-differentiated exchanges and increased reliance on communication infrastructure.

The advent of automated trading has put an onus on market participants "optimizing the geographic location of their servers," according to the letter. It is all about speed and computing power now, it said.

"These changes have effectively placed others with less sophisticated infrastructure at a disadvantage," the letter said.

In particular, the bank takes issue with Rule 611, a part of regulation NMS, designed to ensure best execution on trades. In simple terms, Rule 611 is meant to stop an investor buying a stock at $10 at one trading venue when it is quoted at $9.99 at another.

The SEC Market Structure Advisory Committee addressed some of the concerns around Rule 611 in an April memo, including the contention that the rule had contributed to greater fragmentation of trading.

Goldman takes issue with the exchange-affiliated routing broker-dealers, or the bits of the exchanges which route orders to other trading venues. Here is the key passage (emphasis ours):

With the adoption of Regulation NMS, exchanges established broker-dealer routing entities as a means to route to protected markets in compliance with Rule 611. Since that time, these exchange-affiliated routing broker-dealers have continued to expand their service models, notwithstanding their regulatory status as facilities of exchanges. As highlighted in various letters filed by the Securities Industry and Financial Markets Association ("SIFMA"), this regulatory disparity has led to perceived conflicts of interest, blurring the distinction between the public operations of exchanges and the operations of their affiliated routing broker-dealers. For example, we are concerned that exchange-affiliated routing broker-dealers may have access to and use the proprietary market data of the exchange to benefit their own order routers. Consistent with the themes raised by the industry in the SIFMA letters, we urge the Commission to undertake a review of the structure and operations of exchanges to ensure that there are adequate regulations enforcing the arms-length separation between their operations as public exchanges and those as non-public broker-dealers.

The letter has a couple of other interesting nuggets too. Here is Goldman Sachs on high-speed trading (emphasis ours):

To be clear, we do not believe the speed of trading, in isolation, is a problem. However, speed, coupled with US equity market fragmentation of non-differentiated exchanges, has resulted in an overly complicated marketplace. The US equities markets are mature and move in sub-thousandths of seconds, which forces firms like ours to invest in lower latency technology to remain competitive. However, the value to investors from this non-stop race for faster speeds may have reached a point of diminishing marginal returns for market efficiency and stability.

The letter also makes a number of recommendations to the SEC, including mandating that public market data be disseminated to all market participants simultaneously. Here is Goldman again:

Exchanges currently disseminate prices and transaction data to the SEC-sanctioned distributor for all investors, but exchanges may also send this information directly to private subscribers. While the data leaves the exchange simultaneously, the public stream is delayed because it goes through the intermediary's processing infrastructure. The public aggregator should release information to all market participants at the same time.