Stock Trading Overhaul Proposed
Citing the growing force of technology, federal regulators Tuesday proposed one of the biggest overhauls of stock-trading rules in three decades, including a measure that could shift business from the tradition-steeped New York Stock Exchange to its electronic rivals.
The proposals by the Securities and Exchange Commission could alter a tenet of the stock market: that brokerage firms and mutual funds always must try to get the best stock prices for investors, selling shares at the highest possible prices and buying them at the lowest.
This is known as the “trade-through” rule, because it bars investors from trading through, or bypassing, anyone offering a superior price.
The rule has been a cornerstone of regulators’ efforts to protect small investors, who have little power to control how the stock market’s various intermediaries handle their trades.
Tuesday’s proposed changes would allow the intermediaries in certain situations to choose the fastest trade, even if it wasn’t at the best quote, if their clients permitted them to.
The potential modification of the trade-through rule is particularly relevant given Wall Street’s recent scandals, including at the Big Board, where five specialist firms have agreed to pay about $240 million to settle investigations of alleged improper trading.
If investors could go with the fastest trade instead of the best price, that could undermine the influence of traders on the NYSE floor, where human intervention makes trading slower than on the electronic markets but often provides better prices.
Advancing technology has changed the nature of stock trading -- recently forcing the NYSE itself to boost its computerized trading -- and forced regulators to rethink decades-old trading rules. What’s more, critics say the NYSE has hidden behind the trade-through rule for years to thwart emerging electronic-trading rivals.
SEC Chairman William H. Donaldson compared the evolving financial markets to a highway system that has changed radically over time: “Don’t we have to change the rules and regulations to protect the people who are driving and the people they might bump into?”
He added: “The critical issue is how to capture the benefits of speed and certainty of execution while maintaining the bedrock principle of assuring that all investors -- large or small -- are protected so that their better-priced orders are protected.”
Supporters of the SEC plan, including Nasdaq and a variety of upstart electronic markets, contend that speed of execution often is the most important factor in a stock trade.
They also claim that NYSE specialist firms take advantage of the rule by “posting” the best prices, thus drawing orders to the exchange but not filling orders at the advertised prices. In some cases, critics say, that’s because NYSE traders never intended to honor the posted quotes. In other cases, it’s because stock prices genuinely change in the time it takes the NYSE to fill orders. Thus, critics say, investors actually may get saddled with inferior prices by going to the NYSE for the putative best price.
Some outside experts support modifying the trade-through rule.
“The biggest winners will be the institutional investors, who will have more freedom,” said William Cline, head of capital markets research at the consulting firm Accenture. “And through their trading, the individual investors who invest in mutual funds and pension funds will benefit.”
The NYSE and its new chief executive, John A. Thain, strongly dispute that notion and have waged a public relations battle against the rule change.
The NYSE estimates that not getting the best price could cost investors, primarily individuals, as much as $3.5 billion a year.
“From a pure protection-of-investors point of view, you should have to go to where the best price is,” Thain said in a meeting with reporters Tuesday.
It is unclear whether the commission will approve the staff proposal or, if it does, how much the NYSE would be hurt.
Though SEC commissioners voted 5 to 0 to put out the proposal for 75 days of public comment before considering a final rule, the debate spotlighted a clear divide on the panel.
Donaldson, the SEC’s Republican chairman, clearly was interested in the approach. But the two other Republicans on the five-member panel -- Cynthia A. Glassman and Paul S. Atkins -- expressed reservations about whether the agency had undertaken all the research necessary for a sweeping new rule, and suggested that the trade-through provision should be eliminated entirely instead of modified.
Atkins, holding up an old photograph of an automobile, suggested the overall approach was as futile as putting modern parts on “an old 1975 AMC Gremlin.”
Democratic Commissioner Roel C. Campos, a supporter of the plan, sought to shift the analogy: “I don’t see it as a gremlin,” he said, adding, “I view this as more of a hobbit,” and Campos applauded its “noble intent.”
The NYSE’s recent push to boost computer trading also might help it withstand any modification of the trade-through rule. The Big Board could be designated a so-called fast market, which would bar other markets from going around it to get faster trades.
The SEC proposed other changes Tuesday, including prohibiting brokers from quoting prices of most stocks in increments smaller than a penny and imposing a cap on trading charges levied by some markets.
