Video: Untangling stock trades?

updated 2/24/2004 7:00:34 PM ET 2004-02-25T00:00:34

Proposed changes to how U.S. stocks are traded, announced by federal regulators Tuesday, would alter the competitive landscape for the New York Stock Exchange and its all-electronic rivals. But the new rules also may have some unintended consequences for investors.

At a meeting in Washington, the Securities and Exchange Commission proposed a change that would allow investors to ignore current "best price" obligations in favor of faster execution of a trade. This would be allowed only if a comparable price — within 1 to 5 cents, depending on a sliding scale — could be obtained faster on an automated market. Individual investors would have to be told in advance that there is some price risk in opting out.

“The rule changes are designed to offer greater flexibility to informed traders, while still protecting average investors,” said Annette Nazareth, the SEC's director of market regulation.

The proposed change represents a compromise between keeping the SEC's current "trade-through" rule, as the NYSE would prefer, and doing away with it altogether as advocated by the Nasdaq and other electronic marketplaces. The proposed rules are open to public comment for 75 days and could take effect before the end of the year.

Adopted in 1975, the rule was designed to address the fragmented marketplace for stock trading and to ensure that investors receive the best possible price in buying or selling securities. It requires brokers to route a trade to the market that offers the best price — often the NYSE — to obtain the "best execution" of a customer’s order.

The NYSE’s all-electronic rivals have criticized the rule, arguing that it is outdated because it ignores speedy execution of a trade, their strong suit, which they say is often more important to investors. The Big Board, with its open-auction trading system run by human “specialist” brokers, may post the best price for a security at a given moment, they argue, but the price may change for the worse by the time the trade is completed.

The Big Board specialists and the exchange's new chief executive, John Thain, maintain that the rule protects investors. Without it, they argue, brokers and traders could execute trades on any market, regardless of price.

“I do not think it is good public policy to say I don’t have to go get my customer the best price,” Thain told reporters Monday. At a congressional hearing last week the Big Board chief asserted that eliminating the trade-through rule could cost investors as much as $3 billion daily.

SEC Chairman William Donaldson said Tuesday that recent advances in technology have caused tension between all-electronic markets and "non-automated" exchanges. “There is an increased importance on getting to prices quickly and more efficiently,” he said.

The proposed rule change could divert business from the 211-year-old NYSE, which currently handles about 80 percent of the trades in its listed stocks. In an apparent effort to protect market share, Thain this month proposed increasing the amount of electronic trading allowed at the NYSE.

Institutional investors are now likely to prefer to trade large blocks of stocks using electronic trading systems, said Bill Cline, head of capital markets at consulting firm Accenture.

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The anonymity of an automated transaction offers them the best pricing opportunity, Cline said. This will ultimately benefit average investors, he added, as institutional investors are usually trading stocks on behalf of individual investors, such as mutual fund owners.

The biggest losers are likely to be “slower markets,” Cline added, referring to regional stock exchanges and the American Stock Exchange, which have a smaller portion of the trading volume pie and are less automated than their larger rivals. The NYSE, he added, is moving toward electronic trading. “The Big Board is listening to its constituency — institutional traders who value the speed and anonymity of electronic trading," Cline said.

Michael Goldstein, professor of finance at Babson College in Wellesley, Mass., is less sanguine about the SEC proposed rule changes. He thinks some brokers may use the option to get around their obligation to get the best price for the average investor.

“Markets don’t have to allow everyone to do everything all of the time,” Goldstein said.

“The concept that you’re allowed to pay extra for speed — a difference of a few seconds — it’s on the one hand advanced and on the other silly because it’s not that important for the average retail investor. The pressure for this is coming from big financial institutions ,and some of them seem to want to change the rules to benefit themselves,” he said.

The trade-through proposal is part of a broader package of reforms to U.S. market structure currently being studied by the SEC, including banning the practice of quoting stocks for fractions of a penny, which has encouraged speculators to "jump ahead" of other customers’ orders, thereby driving up the price of stock.

The Associated Press contributed to this report

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