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March 1, 2004

Junk Trade Through, Says Key Congressman

By Gregory Bresiger

The trade through rule is "obsolete" and should be eliminated. That's according to Rep. Richard Baker (R-Louisiana), the chairman of House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.

The trade through rule, which was instituted in 1975, was designed to ensure that listed stocks cannot be traded at a price inferior to any other market. Nasdaq officials, who are joining other Big Board critics in trying to end the rule, contend it denies investors a choice among the best execution venues.

Baker, in a letter to Securities and Exchange Commission Chairman William Donaldson, called the controversial rule "an ossified relic of the time when intermarket competition was in its infancy, and spreads were much wider."

An NYSE spokesman disagreed. "We don't want to get into a public argument with Congressman Baker. We will answer him when we are invited to speak before his committee," the spokesman said.

Nevertheless, Baker, who wrote his letter prior to House hearings in New York City last month, also argued that the NYSE, because of the rule, is exercising "virtual monopoly" powers in the trading of listed securities. And, besides pricier transactions, Baker charged that the trade through rule results in a poorer quality of executions than in the electronic markets.

"Many investors," Baker wrote, "define best price in terms of certainty of execution, speed and anonymity. However, the trade through rule hinders investors from implementing these alternative execution strategies by forcing investors to use slower, manual markets, in effect protecting the monopoly of the specialist system."

But the Big Board, in a research paper, said the rule is vital if individual investors are to obtain the best price.

"If one stock exchange displays a better quote than is available on another market, then specialists and market makers are generally required by SEC regulation ("trade through rule") to route the orders to the market with the better price. This helps assure that investors receive the best available price," according to "Potential Costs of Weakening the Trade-through Rule," the NYSE research paper.

NYSE officials said the average client would pay a huge tariff if he or she paid the second best price for a stock. "This would add an average cost of 4.21 cents per share to the transaction. This excess money would go to the dealer or trader who quoted a worse price but nevertheless received and executed the order," the paper noted. This would come to about $3 billion a year in extra execution costs using 93 NYSE listed stocks in the S&P 100 index, according to the paper.