S.E.C. Expands Best-Price Rule on Stock Trading
By FLOYD NORRIS, New York Times
A divided Securities and Exchange Commission yesterday approved new rules on how stocks are traded that will keep brokers from sending trades to markets that are not offering the best prices available.
Two Republican members of the commission, who opposed the rule, argued that the S.E.C. was impeding competition between exchanges. But the chairman, William H. Donaldson, also a Republican, and the two Democratic members favored the change and argued that it would save investors hundreds of millions of dollars.
The change, adopted on a 3-to-2 vote, would extend to the Nasdaq market a rule that has long covered stocks traded on the New York Stock Exchange, barring brokers from executing a customer order at a price worse than the best price then available on any market. That is known as the trade-through rule.
"In formulating this proposal, we have kept our eye on one overriding objective - the protection of investors - with particular attention to the concerns of small investors," Mr. Donaldson said. He said that currently on the Nasdaq one in 40 orders involved trade-throughs, and he called that unacceptable.
Annette Nazareth, the head of market regulation for the commission, said the rule would save investors as much as $321 million a year, most of it involving Nasdaq trades.
The commissioners who voted against the rule, Cynthia A. Glassman and Paul Atkins, said any savings would be small. Ms. Glassman said $321 million was less than one one-hundredth of a percent of annual trading volume.
Mr. Atkins said the rule would damage competition by mandating a "government-imposed market model." He said consumers should be allowed to choose any market, whether or not it offered the best price.
Mr. Donaldson tried to deflect arguments that the rule was not in keeping with conservative principles, calling it "pro-competitive" and saying that the commission had to deal with conflicts of interest between brokers and customers and "unequal bargaining power among different kinds of investors."
The rule was opposed by some institutional investors, including Fidelity Investments. But the Investment Company Institute, a mutual fund trade group, supported it.
The battle took on a political coloration that has traditionally been absent from S.E.C. votes, with some lawmakers complaining that Mr. Donaldson was wrong to side with the two Democratic members.
Representative Richard Baker, a Louisiana Republican who is chairman of a subcommittee with jurisdiction over securities laws, called the commission vote a "horrible step toward making our free market system substantially less free."
Mr. Atkins said he hoped legislators would intervene, adding that the 1975 law instructing the commission to establish a national market system was a relic of "discarded hyper-regulatory notions."
But Senator Charles E. Schumer, Democrat of New York, said the rule would "strengthen the markets and make them much more transparent."
Joel Seligman, the dean of the law school at Washington University in St. Louis and the author of a history of the S.E.C., said the commission had seen dissents in the past, but that those disputes were fundamentally different. "I have never seen a commission this politicized," he said. "It is deeply troubling in terms of their ability to do their job."
Opponents of the trade-through rule have long claimed that it inhibited innovation by preserving the market share of the New York Stock Exchange, which usually offered the best price but had a trading system that was scorned as slow and cumbersome.
In considering revisions, the S.E.C. made clear that it thought those complaining had a point and determined that brokers could choose to bypass slow markets even if they had better prices.
That led the New York exchange to announce plans to revamp its systems to allow automatic execution of trades at the best prices being offered. The commission determined that that move qualified the Big Board as a fast market that could not be bypassed, assuming it completes the changes by next spring, when the phasing in of the rule is to begin.
Opponents said that any concerns over how brokers would treat customers could be met by enforcing "best execution" rules. But Mr. Donaldson said it was very difficult to enforce that rule in individual cases, and Mr. Seligman said the argument that investors could be protected by that rule was "cloyingly naïve."
The commission had said it was considering two versions of the rule, and chose the less ambitious one that provides protection only for orders at the best price. A limit order on any market that is the best price available on that market will have to be executed if a broker wishes to trade through that price. So if an investor's limit order to buy 500 shares of a stock at $20 is the best order on the New York Stock Exchange, that order must be executed before shares are traded anywhere for under $20.
But other Big Board limit orders would not be protected. So a limit order to buy 200 shares at $19.95 could be ignored without violating the rule as a large block of stock is sold at $19.75 on another market. The expanded version of the rule would have protected the entire disclosed order book, but that was rejected.
One feature of the rule that is different from current practice is that the best bid on each market is to be protected. So in the case above, while an offer at $19.95 on the New York market would not be protected, one at the same price on another market, like the Boston Stock Exchange, would be protected if there were no better bids on that market.
The rule would also put a limit of 0.3 cent a share on fees that a market may charge to other markets for access to its market. It also imposed a new formula for distributing to exchanges the fees that are generated from selling market data to investors.