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Rules For Electronic Trading Debated

Electronic communications networks and Nasdaq demand rule changed that they say favors the New York Stock Exchange.
The Securities and Exchange Commission has ignited a debate over whether investors should choose between slightly better share prices versus speed and certainty of order execution. The outcome could decide whether the New York Stock Exchange continues to dominate its market or lose ground to electronic exchanges.

At a rancorous meeting Tuesday, the SEC proposed relaxing the 30-year-old trade-through rule under which markets are prohibited from ignoring, or "trading through," a superior price posted on another market. Electronic communications networks and Nasdaq have demanded that the rule be abolished, arguing that it stifles competition by causing orders to be diverted to NYSE, which often posts superior prices but can take up to 30 seconds to execute a trade.

Under the proposal, investors would be allowed to opt out of the trade-through rule, in effect sacrificing a few pennies per share in exchange for speed and certainty of execution. The proposal is subject to a 75-day comment period, after which the SEC will issue a final rule.

The proposal could have a negative impact on NYSE's market share, which has held at about 80% despite the advent of electronic communications networks such as Instinet Group and ArcaEx.

While continuing to defend its floor-based trading model, the NYSE has promised to speed up execution. Its CEO, John Thain, has expanded access to its electronic trading system, Direct Plus. A spokesperson says NYSE has submitted a request to the SEC to make Direct Plus even more accessible, but it opposes "eliminating or impeding investors' rights to the best price."

Nasdaq, for its part, has enhanced its SuperMontage order-entry system over the past year to offer greater anonymity and prices from other exchanges, including NYSE. It says it supports the SEC's proposal but will review it "thoroughly" during the comment period.

In proposing to let the trade-through rule stand, albeit with an opt-out provision, the SEC appears to be taking the NYSE's viewpoint, says Celent Communications analyst Jodi Burns.

Few investors are savvy enough to appreciate the subtleties of price versus speed of execution, she says. If enough of them fail to opt out, the SEC may use that as evidence that price is more important than speed--precisely the argument NYSE is making.

Investors are, in fact, willing to forgo small price advantages in exchange for speed, she says. "I may want to direct my order to the market maker who can execute, even if they're quoting a few pennies worse than the best price."