Isn't this mainly a problem with thin issues that daytraders are not really interested in? I am skeptical of changes that seem to be designed to hinder ECN functionality, but maybe this is not such a big deal. Who exactly benefits and who doesn't?
Donaldson's Dinosaur April 4, 2005; Page A14 Wall Street Journal SEC Chairman William Donaldson is the powerful man he is because the U.S. has the most competitive financial markets in the world. So we have to wonder why he is about to use that power to preserve a monopoly for the very symbol of that capitalism, the New York Stock Exchange. The Republican Mr. Donaldson will do so on Wednesday when he is expected to join the two Democratic commissioners on the Securities and Exchange Commission to alter the national stock market system. (The other two Republicans will vote no.) By voting to not only perpetuate the outmoded "trade-through" rule but extend it further, Mr. Donaldson will be handing a plum to his old employers at the Big Board who want to protect their "specialist" trading system. Along the way he'll be saddling the nation's investors with less efficiency and competition. The irony here is that this entire exercise began as an SEC effort to modernize the national market system, the regulation of which has changed little since the 1970s. Leading the to-do list was reform of the trade-through rule, which was introduced in 1975 and dictates that traders must do business with whatever exchange shows the "best" price for a stock. That rule might have made sense back in the days of slow and regional markets. But with today's technology allowing for instant trading, the rule has become a roadblock to the very efficiency and competition it was designed to foster. Above all it has handed an enormous advantage to the NYSE's slow-moving floor system, since that large exchange often shows the best price. How big an advantage? According to recent Congressional testimony, the Big Board has maintained about an 80% market share of listed securities, while Nasdaq, which isn't bound by trade-through, has kept only about 20% of Nasdaq-listed shares. The rest has gone to newer electronic networks such as Instinet or Archipelago. These electronic exchanges have succeeded because they understand that investors value other things as well as price -- certainty of execution, speed, anonymity -- and use them to attract business. This sort of healthy competition is forbidden by the trade-through rule, which demands that traders buy securities on price alone. All of which is why the SEC's original idea was to give investors more choice by providing a trade-through opt-out. But that threatened the NYSE, which has lobbied Washington hard, and successfully now that Mr. Donaldson is siding with his old employer. With prodding from the SEC staff, Mr. Donaldson has also agreed to drop the opt-out and extend trade-through to Nasdaq. All that's missing is any rationale for doing this. One uncomfortable fact is that less than two weeks before the SEC unleashed its revised proposal in December of last year, it extended for the third time a pilot program that gives limited relief from the trade-through rule to certain exchange-traded funds. The extension was granted because the pilot has been successful at improving liquidity and making the market more efficient. Why introduce a pilot if you're going to ignore its success? Mr. Donaldson has also ignored the growing body of academic evidence showing that the quickest way to well-functioning markets -- with the best prices, low bid-ask spreads, efficient price discovery and reduced volatility -- is competition. Many statistics already bear out the benefits to investors. For S&P 500 stocks listed on both exchanges, the shares have a narrower effective spread on Nasdaq than they do on the NYSE. Nasdaq's speed of execution is also some three times faster. The agency also has failed to show that investors or markets have been harmed by the absence of a trade-through rule on Nasdaq-listed stocks. Mr. Donaldson argues that the extension of trade-through is needed to protect limit orders (orders to brokers to buy or sell at a specific price), which aid in liquidity. Yet electronic exchanges such as Instinet, which aren't bound by today's trade-through rule, only accept limit orders and have flourished. Mr. Donaldson has also argued that the rule is the only way to "maintain the confidence" of small investors in the market. But the "best price" isn't always the best for very long. By the time a trader has filled a portion of his order at the "best price" on one exchange, the price may have worsened wherever he goes to finish it. In any case, most individual investors have their money in the market via pension or mutual funds, the very institutions that would benefit most from an opt-out. We're left to conclude that this is all being engineered to help the NYSE. The Big Board is gradually introducing technology that will help it to better compete with faster electronic networks. But it needs time for the transition, and Mr. Donaldson is apparently acting as its protector. We have nothing against the NYSE's specialist trading system, if it is able to hold its own in the marketplace. But giving the Big Board special protections goes contrary to the very mission of the SEC -- which is to promote competitive and efficient markets.
Schwab attacks SEC's stock 'trade-through' rule Tue Apr 5, 2005 02:58 AM ET NEW YORK, April 5 (Reuters) - U.S. stockbroker Charles Schwab Corp's (SCH.N: Quote, Profile, Research) founder and chief executive said on Tuesday that a proposed new market rule designed to ensure investors get the best price when buying stocks on the open market will not work and would discourage competition. The controversial measure, known as the "trade-through rule", is part of a new package of stock-trading regulations which the Securities and Exchange Commission is set to vote on on Wednesday. "The trade-through rule will not benefit public investors and may cause significant harm to our equity markets," wrote Charles Schwab, in an editorial column in the The Wall Street Journal on Tuesday. The rule bars brokers from bypassing the best price offered for a stock when executing an order, even if the best price is on another market or if the best price is only for a small amount of shares. Long in place at the New York Stock Exchange, the rule would be extended to the Nasdaq market if the SEC's five commissioners vote in favor of it on Wednesday. The rule has been heavily backed by SEC chairman William Donaldson. Schwab, whose brokerage has more than 7 million customer accounts, said the rule does not guarantee the best price for customers in today's fast-moving marketplace. "It's often the case that a customer will voluntarily bypass (trade-through) the best quote, which may be good for only a small number of shares, in favor of getting their whole order executed all at once for a better overall price," wrote Schwab. Trade-throughs, which are relatively rare, were actually arbitraged out of the system in heavily traded stocks on Nasdaq, where the rule does not currently apply, said Schwab. Introducing the rule there would discourage competition, he said. "No one will invest in new bells and whistles to improve markets if there can be no competitive advantage," he said. © Reuters 2005. All Rights Reserved.
May We Trade Through? By CHARLES SCHWAB April 5, 2005; Page A18 Wall Street Journal It's not often that an arcane market structure rule intended to protect public investors generates the level of controversy that surrounds the Security and Exchange Commission's proposed trade-through rule. Why should you care? Because it has the potential to significantly change our stock markets, neatly placing sand in the gears of a fast, efficient, highly competitive trading system relied on by millions of Americans every day. As you might guess, when government agencies take action claiming to protect public investors, I take particular notice. My business is focused exclusively on individual investors and the investment advisers who serve them. With over seven million individual customer accounts at Schwab, we are a guardian of the financial futures of multiple generations of Americans. We assume that role gravely. That is why I write to disagree with the SEC's proposal. In my view, the trade-through rule will not benefit public investors and may cause significant harm to our equity markets. And it is a mistake to adopt such sweeping change in the absence of a clear mandate from investors. Nevertheless, the SEC intends to bring the debate to a head on April 6 even though there is no consensus within or without the Commission. House Financial Services Chairman Michael Oxley and Capital Markets Subcommittee Chairman Richard Baker have asked the SEC to proceed with caution and act incrementally. The securities industry is deeply divided over the proposal, which is backed by the NYSE and other floor-based exchanges, and opposed by Nasdaq, other electronic markets, and a number of major institutions like Calpers and TIAA-CREF, who represent individual investors. The SEC itself appears divided three-to-two on the issue. So what are "trade-throughs"? And why is disruptive change required to eliminate them? "Trade-through" is old exchange-floor jargon for when a specialist on one exchange ignores a better quote on another market and executes (i.e., "trades through" that quote) for a worse price. The exchanges and the SEC are now using the term to mean any execution that did not receive the best price, but that's a misnomer. All customers want to get the best price; but in today's fast-moving markets, it's often the case that a customer will voluntarily bypass (trade-through) the best quote, which may be good for only a small number of shares, in favor of getting their whole order executed all at once for a better overall price. In other words, it's not that customers are preferring speed over price -- it's that they often choose the faster execution because they've found from experience that it will lead to an overall better price. This is as true for the individual customer buying 500 shares as it is for the institution buying 50,000. In an ideal world, trade-throughs should never happen because investors would theoretically have enough time to execute against the best quote first, even if good for only a small number of shares, before moving on to the next best quote, and so on. In reality, however, a stock often trades many times a second and the next best quote is often gone by the time the first part of an order is executed -- which explains why a customer may prefer to trade through the first best quote. In any case, trade-throughs are rare, even by the SEC's own estimates (less than 2% of the time). Independent analyses find they happen even less than that. Do these numbers really justify changing how the other 98% or more of orders are handled? Most troubling is the SEC's plan to extend the trade-through rule to Nasdaq, a market that is already highly competitive and efficient. So much so that in popular stocks like Microsoft or Intel, executions occur at spreads of a penny, and often less (no spread at all) for customers using limit orders. What happens to the occasional order that gets traded through? The instant trading occurs at prices below a bid or above an offer, arbitrageurs leap into action, automatically generating orders to take out the traded-through order. When asked about the inevitable drag on market efficiency from a trade-through rule, Chairman William Donaldson said that several seconds is not too long to wait for an execution. How ironic, given that in today's Nasdaq market, orders traded-through likely wait only milliseconds before multiple orders seek to execute against them. So, it shocks me that the SEC seeks to take us all back to the slower processes of a floor-based system. The proposed trade-through rule will dictate where and at what price orders are executed, with regard only to the best quote, and without regard to other crucial factors, such as depth of trading interest, market efficiency, market impact and firmness of quotes. What is the cost of disallowing choice and the competition it engenders? No one will invest in new bells and whistles to improve markets if there can be no competitive advantage. Even price is not really protected by the Commission's approach, since a better overall price in one market must be ignored in order to execute in a market with a better quote but fewer shares available. What benefit could possibly come from denying customers the choice of where to send their orders? What benefit comes from protecting exchanges from competition? Investors have chosen, particularly in the last decade, the extraordinary innovation that has come from intense competition. Their trades have never been faster, more accurate, better priced, or cheaper. Let's not roll back the clock. Mr. Schwab is founder and CEO of The Charles Schwab Corporation.
I wouldn't be surprised if UBS comes out with the same letter that Mr. Schwab wrote. LOL Yea, definitely market making firms will be hurt with the rule change.
I agree with you... Mr. Schwab is "right", it would be "horrible" if his brokers had to give his clients the best price...how would Mr. Schwab and his dynasty survive with a "best price" rule? LOL. The "retail" side of the business is where the concerns are... the actual traders are not going to be affected in reality (at least the way I see it now). I can get price improvement, and then hit an ECN bid or offer....all within 1 second....if it were all about "speed" then it might be different, but those days are long over with...IMO. Don't get me wrong about Charles Schwab, I think he is an excellent businessman, and did a lot for the industry back in the day....but I think his letter might be a bit self-serving (don'tcha think?). We'll see how it all pans out....I don't see a big deal either way, I would just like to continue to get better pricing when I can. Don
Big Board Still Carries a Big Stick NYSE Uses Its Political Weight To Soften Governance Proposals That Would Hurt Floor Trading By AARON LUCCHETTI Staff Reporter of THE WALL STREET JOURNAL April 5, 2005; Page C1 In the last two years, the New York Stock Exchange ousted its chairman amid a pay scandal and saw the Securities and Exchange Commission fine the trading firms that oversee auctions on its floor for shortchanging investors. The NYSE, however, still wields considerable clout in Washington. When the SEC votes tomorrow on a package of new rules that govern stock trading, the Big Board is expected to get much of what it wants. Its main rival, the Nasdaq Stock Market, by contrast, is expected to lose its fight to keep the SEC from applying a key part of the rule to trading in its listed stocks. The most-contentious of the changes is designed to ensure that investors get the best price available when they buy and sell stock. In addition to expanding best-price protection for the first time to stocks listed on the electronic Nasdaq market, the new "trade-through rule" also attempts to speed up trading in stocks listed on the NYSE. Big investors have long complained that an old version of the rule forced them to trade on the NYSE despite slow execution. The new trade-through rule would require investor orders to be filled at the best price that can be executed immediately. That would take away best-price protection from slow orders handled manually on the NYSE floor, allowing them instead to be handled by electronic rivals of the Big Board. To avoid losing market share, NYSE chief executive John Thain has proposed a hybrid market under which electronic trading will co-exist with the exchange's traditional method of having traders buy and sell stocks on its storied floor in lower Manhattan. [William Donaldson] The expansion of electronic trading will likely be challenging for the brokers and specialists who work on the floor of the 212-year-old NYSE. But in a 14-month lobbying campaign led by Mr. Thain and a team of politically connected managers he has assembled, the NYSE beat back two proposals that could have spelled the death knell for its traditional floor-trading model. The Big Board made a "significant concession" with Mr. Thain's plan to expand electronic trading, says Benn Steil, a senior fellow in international economics at the Council on Foreign Relations who is also a nonexecutive director at virt-x, a European electronic stock exchange. But in more-recent wrangling over details of the rule, "the NYSE has gotten everything it has wanted," he says. The SEC initially proposed weakening the NYSE's best-price protection by making it optional in some circumstances, which would have sent trading volume to the NYSE's electronic rivals. The idea was popular with some large investors such as Fidelity Investments, the nation's largest mutual-fund manager, Wall Street firms such as Morgan Stanley, and some members of Congress and state and county officials who wrote to the SEC last spring. [John Thain] But Mr. Thain, a former Goldman Sachs Group Inc. executive who joined the NYSE as chief executive in January 2004, traveled to Washington at least twice to personally lobby against the change. In all, NYSE officials met with the SEC eight times between March and June, making their case. A few months later, the agency dropped the idea of an optional trade-through rule. But there were more surprises to come. In November, Mr. Thain learned that the SEC was thinking about applying the trade-through rule in a way that could drain significant trading volume from the NYSE floor. Specifically, the idea would allow for electronic matching of orders across markets, not just for each market's best price, but for every order that had been placed on the markets' books. The NYSE feared the idea, known as "depth of book," threatened Mr. Thain's plan to expand electronic trading while maintaining a role for floor traders. In separate meetings with SEC Chairman William Donaldson and another SEC commissioner just before Thanksgiving, Mr. Thain argued against the SEC's depth-of-book idea. Two weeks later, at a meeting of an NYSE's advisory board made up of Wall Street insiders and others, Mr. Thain repeated his battle cry. One board member asked where the idea had come from. Mr. Thain looked across the table at Henry Paulson, his former boss at Goldman Sachs, people familiar with the meeting say. Months earlier, Goldman had come out in support of the SEC idea. Mr. Paulson, the firm's chairman and CEO, defended Goldman's support of the depth-of-book idea, but said he didn't want to support a proposal that would hurt the NYSE. Goldman backed away from public support of the idea. Goldman yesterday had no comment. When the SEC published a revised proposal Dec. 16, it mentioned the depth-of-book idea as a possibility, but sought public comments on it. The NYSE, led by its new head of government relations, former State Department undersecretary Margaret Tutwiler, helped organize a letter-writing campaign that yielded more than 1,500 letters on the exchange's behalf, including pleas from H.J. Heinz Co. and Sen. Elizabeth Dole (R., N.C.). In mass e-mails, exchange officials contacted companies whose stocks trade on the Big Board. Rep. Richard Baker (R., La.), head of a key congressional subcommittee, criticized that tactic, saying the NYSE shouldn't lobby companies it has sway over as a quasi-regulator that sets governance standards for companies listed on the exchange. The stock exchange pulled out all the stops. Many floor traders wrote their own letters, while others persuaded friends and family to write. Some SEC officials were surprised by the outpouring of support for the NYSE. In congressional testimony last month, the SEC's Mr. Donaldson noted that the depth-of-book idea hadn't gained much traction. At the hearing, lawmakers also grilled Mr. Donaldson on the SEC's plan to extend best-price protection to Nasdaq stocks. Rep. Baker, a supporter of many of Mr. Donaldson's initiatives, called it "the worst public policy I have seen in my nearly two decades in Congress." Nasdaq and other electronic markets have argued against the rule, saying investors and not the government should say where to stock should be bought and sold. During the 2004 election cycle, Nasdaq representatives and its political action committee contributed about $7,000 to Mr. Baker while representatives of electronic stock-trading network Instinet Group Inc. contributed about $11,750, according to Federal Election Commission documents. Nasdaq says the rule will likely increase costs for investors. It has also questioned studies used by the SEC to justify applying the rule across the board. But with a 3-2 SEC vote imminent, officials at Nasdaq now appear resigned to dealing with a best-price rule, people familiar with the matter say.
Divided SEC Approves Changes To the Nation's Stock Markets By JUDITH BURNS DOW JONES NEWSWIRES April 6, 2005 2:23 p.m. WASHINGTON -- The Securities and Exchange Commission voted 3-2 to adopt a controversial plan to revamp the nation's stock markets by guaranteeing investors get the best price available when buying and selling stocks. SEC Chairman William Donaldson joined the two Democrats on the five-member commission in approving the measure. The two Republican commissioners sharply criticized the rule as anticompetitive, costly and bureaucratic, and encouraged Congress to intervene. The rule requires investor orders to be filled at the best price that can be executed immediately without human intervention, applying to all markets and nearly all types of stock orders. The national market-system rule -- known as Regulation NMS -- also requires that brokers "sweep" all markets to find the best price for a stock at a given moment. Traders no longer can "trade through" the best price offered for a stock when executing an order, even if it meant being able to move a large block of stock as quickly as possible. That best-price rule, aimed at protecting investors, has been criticized by Fidelity Investments and other large investors, as well as some electronic-trading sites, including the Nasdaq Stock Market and Instinet Group Inc. Electronic markets argue they shouldn't be slowed down trying to get the best price because the presence of large trades often quickly drives prices up or down to their disadvantage. Electronic markets have a speed advantage over the Big Board, which argues that getting the best price is more important. Republicans in Congress have fiercely criticized the plan since it was tentatively approved in December and have raised the possibility of a legislative challenge. The SEC will begin phasing in the new rules starting April 10, 2006, with 250 stocks -- 100 from the New York Stock Exchange, 100 from Nasdaq, and 50 from the American Stock Exchange. All stocks traded on U.S. markets will be subject to the same rule starting June 12, 2006. New restrictions on quoting stocks in prices at a fraction of a penny will take effect sooner, starting July 1, the SEC said. Another aspect of the plan, which will change the allocation of market-data revenue, takes effect in July 2006. Mr. Donaldson defended the changes, saying they will help ensure investors get the best price when buying or selling stocks. "This is, as far as I'm concerned, not a political question," Mr. Donaldson, a Bush appointee to the SEC, said after the agency's public meeting to consider the rule. He said the SEC has to be independent of "political affiliations" and do what is best for investors. Annette Nazareth, director of the SEC's market-regulation division, said Regulation NMS will be far more effective than current rules at preventing trading through the best price posted on one market to a worse price elsewhere. She conceded, though, that trade throughs won't disappear altogether. The new rule will apply only to best displayed prices. The SEC scrapped the idea of extending it to other prices, those in the "depth" of a market's order book, on a voluntary basis. The final plan also omitted an earlier idea to allow market participants to "opt out" of trade-through protections if they wish. The SEC's approach is expected to speed the development of electronic trading at the NYSE and other markets known for traditional trading on the exchange floor through specialists and floor brokers. Critics said the new rules may chill future innovation and technological development, and questioned whether Nasdaq and electronic markets need a trade-through rule at all. SEC economists estimated about 2% of orders on Nasdaq and the NYSE are traded through, and SEC officials disagreed on whether that level is high enough to be of concern.