NYSE to Repeal Rule Forbidding Off-Floor Trades

New York Stock Exchange directors today are expected to remove one of the Big Board’s most enduring barriers to competition, a rule that forbids member brokerages from trading certain NYSE-listed stocks away from the floor of a traditional exchange.

Dropping Rule 390, together with several steps that the Securities and Exchange Commission is expected to take next week, could speed progress toward a national marketplace for stocks--not a single, central exchange, but a shared trading system where investors could see prices being quoted by all competing market venues.

Supporters say more competition among venues will pay off for investors in the form of better prices and faster executions.

The moves by the Big Board and SEC should ultimately spur the growth of the upstart electronic trading networks known as ECNs, which are already trading extensively in Nasdaq issues.

But the first beneficiaries of the elimination of Rule 390 would be large brokerages such as Merrill Lynch and Goldman Sachs & Co., which have long been pressing for the change: They would be able to trade directly with their customers, or match one customer’s buy order against another’s sell order in any NYSE-listed security, without having to route such transactions through the Big Board or a regional exchange.

NYSE member firms also would be able to send trades to ECNs as they see fit.

“This will very quickly change the landscape positively by giving [brokerages] more flexibility to execute orders most efficiently for their customers,” said Bernard L. Madoff, whose Madoff Investment Securities is one of the major “third market” firms trading NYSE issues.

Rule 390 applies to all stocks listed on the NYSE before April 26, 1979--or about 30% of the 3,100 listed stocks. They account for 48% of trading volume and 25 of the 30 Dow Jones industrial stocks.

Though the NYSE has long contended that Rule 390 protects investors by bringing trades to the largest marketplace, the SEC and much of Wall Street--not to mention rival stock markets--now consider it to be anticompetitive.

Prodded by SEC Chairman Arthur Levitt, NYSE Chairman Richard Grasso will recommend to his board at this morning’s meeting that the rule be scrapped.

And in Washington next Wednesday, Levitt and his four fellow commissioners will consider proposals to give members of the National Assn. of Securities Dealers--Nasdaq’s parent--access to NYSE Rule-390 stocks, and to allow regional exchanges to participate in the first day of trading in NYSE initial public offerings.

The SEC will also help shape the debate over how much the exchanges should be allowed to charge brokerages for access to their stock-price data. Discount brokerages, especially online ones, have been pushing for reduced fees for the data, but the SEC is also concerned about protecting a revenue source that helps pay for the markets’ self-regulatory operations.

“The elimination of Rule 390 is a good step toward competition in the listed-stock world,” said Joshua Levine, vice president of the Island ECN. But he said true competition will come only when the SEC either approves the applications of Island and other ECNs to become full-fledged stock exchanges or improves their access to the Intermarket Trading System, which electronically links the NYSE, Nasdaq and regional exchanges.

The ITS is at the heart of the first SEC proposal to be considered next week. NASD-member brokerages now can trade only non-Rule-390 stocks via ITS. But in anticipation of today’s NYSE vote, the SEC would expand access to all NYSE stocks.

That is crucial to the electronic networks, which hope to piggyback on NASD’s ITS pipeline as a way to trade Big Board stocks themselves. ECNs match buyers and sellers directly, often at lower fees than established markets.

However, SEC approval would be only a first step; after that, NASD and ECNs must negotiate access terms, which could be thorny.

Some Big Board partisans warn that as brokerages move more trading away from the NYSE floor and into new, lower-cost channels, investors might not always get the best price. Madoff, for one, disagrees.

The brokerages, he said, “don’t need the NYSE to give them a conscience--they already have it.”

Another concern raised by the push for greater market competition is that it could lead to excessive fragmentation and price wars that would sap trading venues’ profits and drain capital out of the markets, making them riskier for investors.

But Island’s Levine argues that “increased competition always leads to decreased cost, increased quality, or both. Good market structure encourages everyone to add liquidity to the marketplace rather than depending on a single person--like the specialist on the NYSE--to do so.”