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December 1, 1999

Dealers See Chance for Trade-Through Protection

By Peter Chapman

The order display facility proposed by Nasdaq could bring trade-through protection demanded by dealers.

The proposal envisages a "super montage" accessible by market makers and electronic communications networks, which aggregates trade sizes at various price levels. The plan to integrate SOES and SelectNet could substantially reduce the incidence of orders that are "traded through," some trading officials say.

Trade-throughs on Nasdaq typically happen when a small limit order on the inside goes unfilled as a market maker executes a much larger trade for his customer away from the inside price. The market maker decides the inside price doesn't represent the market for a large trade for him, a trading pro explained. The dealer behind the small limit order, however, stands by as he is traded through.

Traders handling smaller-size orders are clamoring for trade-through protection. Nasdaq has never passed a trade-through rule. Now traders want Nasdaq to pass a rule requiring block traders to take them out before they fill their larger orders. Block traders counter that the slowness of the SelectNet process and the absence of an automatic execution mechanism make it too troublesome to catch all those little quotes.

Dealers are encouraged by Nasdaq's plan to integrate SOES with SelectNet to give market makers automatic execution capabilities.

"We've been asking for a trade through rule for the last two years," said Bernard Madoff, chairman of the Security Industry Association's trading committee. "We've always made the assumption that a rule would be done in conjunction with an electronic order routing system. I'm hopeful the [order display facility] will make a rule possible."

Nasdaq's new system isn't expected to be operative until next summer-the same time the industry converts to decimalization. Some think decimalization will exacerbate the trade through problem.

"We're seeing more quote activity these days and the more quote activity you have, the greater the potential for trade throughs," said Jerry O'Connell, a compliance officer with Susquehanna Financial Group.

O'Connell says all those flash' quotes make it hard for a market maker to comply with his best execution obligations because they're so difficult to reach.

"It would greatly help matters if market makers were given the equivalent of SOES, so they could get to those bids and offers quicker," he added.

Greg Bokach, an equity trader with American Century, believes a central limit order book with automatic execution and price-time priority is key to reducing trade throughs. "A small seller shouldn't be able to price the market, but they should be able make their trade," he said. "Only in an auto-ex world would you truly have trade-through protection. The [order display facility] will help dramatically."