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August 31, 1998

Trade-Through Rule SeenAs Likely for NODES Proposal

By Staff reports

The National Association of Securities Dealers is expected to submit a separate plan for a revamped limit-order book, the centerpiece of the original proposal for Nasdaq's order-delivery and execution system, or NODES.

The new version of the limit-order book will likely be accompanied by a trade-through rule, according to a member of Nasdaq's Quality of Markets Committee, who declined to be named.

The rule would ensure that superior bids and offers sent to the book receive an execution whenever inferior-priced orders in the same stocks are executed outside of the book.

Trade-through rules are a standard feature of limit-order books run by the New York Stock Exchange and the regional stock exchanges.

An NASD spokesman said the agency is still considering splitting the proposal, but declined to elaborate.

"A limit-order book hinges on price and time priority," the Nasdaq committee member said. "That's why you need a trade-through rule. It would create a central place and protect the customer."

Centralize

Nevertheless, the Nasdaq committee member warned that a trade-through rule would centralize the market.

"That may be why the NASD initially resisted it," the Nasdaq committee member said. "But you really can't have a limit-order book without a trade-through rule."

The member added that, "overall, the plan would auctionize the dealer market by centralizing quotes."

STA Letter

In a comment letter, the Security Traders Association urged the NASD to adopt the trade-through rule under NASD consideration.

Separately, the STA said the NODES proposal raised the issue of credit reliability.

"Where is the line of responsibility for assuring proper credit, particularly if a customer is trading anonymously through a broker dealer?" the STA asked in the comment letter filed with the Securities and Exchange Commission on June 11.

"Should any broker dealer have the ability to enter proprietary orders for 999,000 shares? Is a firm responsible for customer transactions effected outside the knowledge of the respective broker dealer?" the letter asked.

Time

The STA also raised questions about the time parameters of NODES, and argued that the proposed three-minute close rule would be disadvantageous for the market.

"The current rule allowing a five-minute window, with a 20-day suspension for market making for failure to update, has proved sufficient," the STA said.

Both the 17-second and the 32-second delivery parameters are too confusing, and the 32-second parameter is too long, the STA said, which proposed a new time parameter of 22 seconds.