Capital Markets

SEC Passes ”Trade-Through” Rule

Both issuers and investors, however, may face some turbulent times as the New York Stock Exchange makes a transition to a hybrid trading model.
Stephen Taub and Craig SchneiderApril 7, 2005

The Securities and Exchange Commission voted 3-to-2 late yesterday to require that all investor trades be executed at the best price, even if stock markets must fill the order through a competitor.

SEC Chairman William Donaldson once again cast the deciding vote on an issue that was opposed by his two fellow Republican commissioners, according to published reports. “We’re attempting through new rules to protect the concept of best bid to be honored in the marketplace,” he said in an interview on the Fox News cable channel.

The “trade-through” rule — part of Regulation National Market Structure (Reg NMS) — is a watered-down version of an SEC proposal from late last year and is widely deemed a victory for the New York Stock Exchange, which Donaldson once headed, according to The Wall Street Journal. The earlier version would have trivialized the role of the NYSE’s specialists, the paper noted. The floor-based trading specialists of the American Stock Exchange also already adhere to the rule

On the other hand, added the Journal, market pros deem the big losers to be electronic exchanges such as the Nasdaq Stock Market. The Nasdaq had hoped that the SEC would allow investors to trade on whichever market they chose, even if it didn’t offer the best price — for example, if investors were more concerned with speedy execution of their orders.

When the SEC considered revisions to the trade-through rule, according to The New York Times, it determined that investors should be able to bypass “slow markets,” even if those markets had better prices. In response, noted the paper, the NYSE announced that it would update its systems to enable automatic best-price execution — which then qualified the Big Board as a “fast market” that could not be sidestepped. Those NYSE changes are scheduled to take effect next spring, added the Times, when Reg NMS will begin to be phased in.

In a December interview with, Steve Braverman, managing director at consultancy Tahoe Advisors, said he believes that the NYSE will have a tricky balancing act as it makes a transition to a hybrid trading model. By his lights, if more orders begin to flow through NYSE’s electronic system — and specialists are restricted in how much they can trade for their own accounts — there’s a greater chance that those specialists could become disengaged.

In the near term, that could be risky for both issuers and investors. Braverman explained that if specialists’ earnings decrease as a result of structural changes in the market, they may lose the incentive to invest capital as often, allowing forces of supply and demand to drive stock prices more freely. “That will lead to more volatility,” he said, and potentially cause major investors to balk at taking positions for fear of moving the market too much without specialist support in times of market stress.

In a statement, Sen. Richard Shelby (R-Ala.), the chairman of the Senate Banking Committee, decried the 3-to-2 vote as a reinforcement of “what appears to be a disturbing trend of actions that have resulted in split decisions,” according to the Journal. Shelby added that “splits dilute the actions of the commission and undermine their authority to speak as a unified body.”

Donaldson’s two fellow Republican commissioners, Cynthia Glassman and Paul Atkins, were outspoken opponents of the new rule. Glassman called it a “massive regulatory intrusion into the operation of the markets that limits investor choice and impedes innovation and competition,” according to the newspaper.

This is the latest rule passed by the SEC on the support of the two Democratic commissioners, Harvey Goldschmid and Roel Campos, including new governance rules for mutual funds and the hedge fund registration requirement. Donaldson also supports the now-languishing proxy access rules, which are also opposed by the Glassman and Atkins.

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