Federal regulators on Tuesday proposed steps to give investors greater flexibility in how their stock trades are executed, in a move that could take business from the New York Stock Exchange.
The Securities and Exchange Commission voted to issue a proposal that would ease the hotly contested “trade-through” rule, which often requires a market to ship an order to trade a stock to another market if a better price is available.
Critics say the time it takes for an order to be handled can cost investors money, because that price can disappear.
While stressing the importance of ensuring the best price for investors, commissioners agreed to put forth a proposal for a rule to allow customers to decide for themselves if they want to trade through, ignoring a better price in exchange for speed of execution. Opting out would have to be done on an order-by-order basis.
In addition, an automated, or “fast,” market could ignore better prices on “slow,” or manual, markets, provided the fast market’s price is within a few pennies. A fast market, however, could not ignore better prices from other fast markets.
SEC and NYSE officials said they believe the NYSE could qualify as a fast market, though no precise definition has been issued.
The plan is part of a larger package on several issues relating to market structure, including market access fees, subpenny pricing and allocation of market data revenue.
Commissioners said market structure is ripe for re-examination, given dramatic changes in recent years. Some said the current proposal may not be sufficient, suggesting that the trade-through rule should be abolished.
“We want our markets to be more efficient, more conducive to liquidity and more transparent to investors,” said Republican Cynthia Glassman.
Democrat Harvey Goldschmid said he supports the concept behind the trade-through rule, but said it needs to be revisited.
“I have concluded that the best-price issue at the heart of the trade-through rule has served the nation well,” he said. “But the trade-through rule needs updating and modernization.”
The issue has generated intense debate within the securities industry.
Overall, the NYSE has benefited from the rule because its specialist-based system usually generates the best price for NYSE-listed stocks, and it handles more than 80 percent of the volume in the shares. Regional exchanges, including the Chicago Stock Exchange, the Nasdaq stock market and electronic communication networks make up the rest.
The NYSE and others have strongly defended the trade-through rule as an important, common-sense investor protection. They say allowing orders to be traded through, even if the price difference is only a penny or two, would add billions to investor costs over a year and could give brokers an incentive to steer orders without regard to the best price for customers.
The NYSE said it would review the more than 300-page plan, but said: “Any provision that eliminates or impedes investors’ right to the best price will be a concern. Best price should remain paramount.”
The Nasdaq, which loses volume in NYSE-listed stocks because of the rule, has pushed to have it repealed. Chief Executive Robert Greifeld has called it “an anachronism.” The Nasdaq doesn’t have a trade-through rule for its stocks, but the SEC proposal would apply to it as well.
Advances in technology mean customers should be able to decide how orders are executed, Nasdaq officials say, because some value speed. Holding up orders, the officials argue, can mean that the originally quoted best price has changed by the time an order is executed.
Greifeld hailed the SEC’s proposals Tuesday as “a significant step forward for investors.”
Some institutional investors and electronic trading platforms, including Chicago-based Archipelago LLC, have challenged the trade-through rule on similar grounds.
The Securities Industry Association and Investment Company Institute mutual fund trade group hailed the SEC’s tackling of the issue, saying the trade-through rule should be reconsidered so customers have greater flexibility.
The floor-based Chicago Stock Exchange, which also has automated trade execution, supports modifications to the rule. CEO David Herron said a customer can miss out on a better price by the time an order gets to the other market, and then miss out on the first price at the original market.
“Speed is important,” Herron said.
Herron said he has reservations about the opt-out provisions, saying they don’t offer any real benefits for retail customers but may present advantages to professional traders.
The SEC proposal now is subject to a 75-day comment period. Commissioners stressed the preliminary nature of the plan and said it’s unclear what form final rules may take.
