McSherry is SVP of Strategic Initiatives at Cuttone & Company.

It has been only four years since the last overhaul of U.S. stock market rules but the events of the last year have all-but-guaranteed that congressional leaders and financial regulators will be once again be tinkering with the way investors buy and sell stocks.

Would-be regulatory architects should exercise caution when altering market structure. If our recent experience is any guide, we may inadvertently create new problems by focusing on specific solutions with insufficient regard for the effect that changes will have on overall market quality.

In 2005, under the leadership of then-Chairman William Donaldson, the SEC issued Regulation NMS, which mandated revolutionary changes in market structure and effectively forced manual exchanges like the New York Stock Exchange to permit direct electronic access to the point of sale.

That aggressive regulatory action has bequeathed us a national market system that is failing to protect the interests of long-term investors, one that has become increasingly dominated by esoteric trading strategies divorced from underlying estimates of corporate valuation.

A sweeping reevaluation of current market structure should be undertaken immediately, before new rule changes are erected atop a flawed regulatory foundation.

Reg NMS presents a textbook case of the dangers of regulatory action. The SEC- mandated rule changes were designed to hasten the adoption of electronic trading, and they succeeded: virtually all stock trading in the U.S. is now computerized.

Unfortunately, those same changes have permitted firms to exploit minute shifts in stock prices by using automated programs to repeatedly trade retail-size orders through ultra-high speed data lines. Those high-frequency trading strategies have become so popular that they are currently estimated to account for more than half of all U.S. trading volume.

Unlike traditional shareholders, the average life of stock ownership by high frequency traders is measured in seconds and minutes—certainly an unintended consequence of Reg NMS. We have become painfully aware of the danger posed when the self-interest of managers diverges from those of shareholders and corporate governance reforms will soon be enacted to combat that agency problem. In light of those dangers, does it make sense to have a market structure that encourages and disproportionately rewards owners with no real stake in the fortunes of the underlying company?

It is often argued that high-frequency strategies add liquidity to markets, but much of that argument doesn't hold up to close scrutiny. High frequency trading strategies, by their very nature tend to focus on actively traded stocks that are already highly liquid, rendering their public utility questionable.

What is not questionable is that the small amount of additional liquidity that high frequency trading does provide comes at the cost of parasitic and potentially manipulative trading activities that feed upon the orders of long-term investors. It is undeniable that high-frequency trading interests often diverge from those who buy and sell based on fundamental estimates of corporate worth.

In the Reg NMS filing the SEC concluded, "when the interests of long-term investors and short-term traders conflictthe Commission believes that its clear responsibility is to uphold the interests of long-term investors." It's time for the SEC to reevaluate our market structure in light of that responsibility.

Even the staunchest supporter of open outcry markets has had to admit that electronic trading has improved our markets yet many longstanding problems continue to plague the industry, exacerbated by the very technologies that had been trumpeted as solutions.

Automated Indications-of-Interest allow firms to data mine public order flow and have replaced whispered phone conversations as a primary source of trading information leakage. Computerized 'sniper' programs covertly manipulate prices and allow high-frequency traders to profit at the expense of public investors.

Transparency, an important measure of market quality, has been dramatically reduced due to the fragmentation of order flow across more than 50 market centers, many of which operate under different regulatory frameworks. Most of these market centers feature "dark" order types that reveal pricing information selectively rather than to the general public.

Trades that once took place in the sunlight of public scrutiny are now consummated in dark recesses of alternative trading systems. As a result, the price discovery process, so vital to efficient market operation, has degraded to the point that a centralized 'best' price no longer exists.

When Congress mandated the establishment of a national market system in 1975 it stated that, "Investors must be assured that they are participants in a system which maximizes the opportunities for the most willing seller to meet the most willing buyer." Current market structure, which allows firms to preferentially route orders without seeking price improvement in the broad marketplace, fails to provide that assurance.

The recent controversy over the improper advantages derived from the use of flash orders illuminates the structural shortcomings that have allowed some technologically advanced firms to act in contravention of long held market principles. Flash orders permit a privileged group of traders to effectively obtain free options that allow them to step in front of publicly displayed orders.

Long-term investors who may wish to utilize limit orders are thus disadvantaged and may feel compelled to buy and sell immediately at inferior prices. One of the primary arguments against the existence of traditional floor-based exchanges was that specialists derived an unfair advantage from a free look at incoming order flow. Shouldn't the same argument hold true in an electronic world?

Industry opinion is shifting and there is a growing consensus that further regulatory reform will be necessary to reach the full potential promised by electronic trading. There is a real danger, however, of further degradation of our markets through misguided reform efforts.

The markets are so complex that small changes have unanticipated effects upon seemingly unrelated trading activities and the danger that incomplete efforts could further weaken our markets is real.

As Congress addresses the failings of our financial system in upcoming months, its gaze will inevitably turn to market structure issues. Let's hope that it resists the temptation to implement jury-rigged solutions and instead opts to deal with the broad design issues that are impairing our markets.

U.S. Senator Ted Kaufman (D., Del) has rightfully called for the SEC to "undertake a comprehensive, independent 'zero-based regulatory review' of a broad range of market-structure issues, analyzing current market structure from the ground up before piecemeal changes built on the current structure increase the potential for execution unfairness." His words should be heeded.

Reg NMS was strongly undermined by a myopic focus on trading speed for speed's sake and it has left us a national market that falls far short of its potential. The process that produced Reg NMS was so arduous that many are reluctant to so quickly reexamine our market structure, but it's clear that the need to do so is urgent. Everything should be on the table, depression-era rules as well as those that accompanied the passage of Reg NMS. Only by examining our markets holistically and through a willingness to modify painstakingly achieved rule changes will we be able to achieve the goal of a modern, fair and efficient market system.

A revolution in stock trading has taken place in recent years, and while it is clear that enormous benefits have been realized, the unintended consequences of modernization efforts have left us with a marketplace that is unbalanced, unevenly regulated and unfair.

By favoring the interests of short-term traders ahead of those of long-term investors, our existing market structure will ultimately raise the cost of capital for American corporations and reduce their global competitiveness.

In the currently fashionable spirit of not letting a serious crisis go to waste, we should view the upcoming period of regulatory reassessment as a unique opportunity to readdress the serious structural flaws that have unfairly disadvantaged long-term investors. That's an effort we would all do well to invest in.

About the Author

McSherry serves as senior vice president of strategic initiatives at Cuttone & Company, where he is a member of the management committee involved with strategic planning and market strategy. He has served in a number of leadership positions within the Industry and has chaired several New York Stock Exchange committees, including the Equity Traders Advisory Committee. He was also a member of the Market Performance Committee and served as a New York Stock Exchange Governor for six terms. He is a past President of the Alliance of Floor Brokers, an industry trade group and is a member of both the Security Traders Association of New York (STANY) and the National Organization of Investment Professionals (NOIP).