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A New Era at the SEC?

Traders Magazine, March 2004

John A. Byrne

The Securities and Exchange Commission, at last, is coming clean about the shocking impact of trading rules it introduced in recent years. The SEC now describes as "troubling" the reported increase in institutional trading costs as a result of these rules. That's despite an unprecedented transfer of wealth - to the retail investor - because of narrower spreads forced by the changes. In November 2003, for instance, these reduced spreads generated savings of some $340 million, which comes to about $4 billion on an annualized basis. That's wonderful for the retail market. But the full truth is painful, so in the end it takes courage for a person or federal institution to excoriate the demons of a dark past. The SEC, in this instance, seems to be breathing oxygen again as it attempts to slowly remove some of the unintended damage done by a series of market structure shocks. These include the order handling rules, decimal pricing and the National Market System (NMS). These rules and structural changes undoubtedly contributed substantial gains to the functioning of the U.S. stock market system. However, much of the design work is condemned as faulty by trading critics. Now the SEC concedes as much in its Reg NMS proposal, making the rounds of every trading desk in America. The SEC says the "most serious weakness" of the NMS is the "relative inability of all investor buying and selling interest in a particular security to interact directly in a highly efficient manner. Little incentive is offered for the display of customer orders - particularly the large orders of institutional investors." The SEC's NMS document is not all about restoring the balance of economic and trading power. In fact, it is a complicated reform package that could, if enacted, require trade-offs between various constituencies. Indeed, the trade through proposal is a fancy bit of footwork. It hands fast, electronic markets the ability to accomplish trade throughs but then blunts that force with an opt-out provision. Still, Reg NMS leaves the impression the SEC wants to lighten the load carried by dealers and other market centers. The SEC proposes capping access fees at one-tenth of one cent. It also includes an esoteric plan to redistribute the money made on market data; and it proposes practically eliminating subpenny trading. To borrow the words of STA President, John Giesea, that latter idea is a "slam dunk" for institutional trading professionals. Nasdaq, which filed last August for permission to adopt a minimum quotation increment of $0.001 in Nasdaq-listed securities, contends that subpennies created one market for professionals who do well, and another market for smaller investors who get hurt. In this dual market, moreover, some participants have an unfair advantage. They can step ahead of others. Nasdaq said it needed subpennies to stay competitive with some ECNs that allow subscribers to use subpennies. In this issue, Traders Magazine has devoted the Cover Story by Pe

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