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August 9, 2006

The Coming Age of Reg NMS

By Peter Chapman

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It wasn't meant to be. The transformation of the stock market into an electronic bazaar was supposed to be a done deal by now. By June 29th, the Securities and Exchange Commission's new intermarket trading rules-part of its Regulation NMS package-were to have kicked in. Most trading would be done electronically and the floor of the New York Stock Exchange was expected to resemble a ghost town. That has obviously not come to pass. On May 24, the SEC scrapped the original implementation schedule for Rules 610 and 611 and announced a new one.

Apparently, the country's stock markets just weren't ready.

"It became evident the markets needed more time to get their systems going," Dave Shillman, an associate director in the SEC's division of market regulation, said at a recent industry gathering.

More Work

Seven of the country's eight stock exchanges plus the NASD's Alternative Display Facility (ADF) are in the midst of top-to-bottom overhauls.

The makeovers are intended to make them compliant with the new rules and competitive in an environment being reshaped by those rules.

The markets still have a lot of work to do. "The SEC has been very responsive to the smaller exchanges in terms of facilitating the implementation of our rules," noted Meyer "Sandy" Frucher, chairman and chief executive of the Philadelphia Stock Exchange, "but the process has been a little slow."

Too slow for many broker-dealers. To a large extent, the SEC decided to reschedule because of concerns expressed by the Securities Industry Association (SIA).

The SIA is representing broker-dealers with the SEC in the ongoing Reg NMS implementation process. In March, it advised the SEC that its members would be unable to even come close to complying with Rule 611 until the end of the year at the earliest.

Broker-dealers need to recode their trading systems to function in the new landscape. They cannot do that until they receive technical specifications from the market centers. So far, no specs have been forthcoming.

Broker-dealers also have a laundry list of questions for both the SEC and the exchanges. They got plenty of answers in January when the SEC issued its by now widely-read "Responses to Frequently Asked Questions Concerning Rule 611 and Rule 610 of Regulation NMS."

But there are still many open issues. Soon, the SEC is expected to provide more answers to broker-dealers' questions. Also, the SIA is awaiting answers to a list of 14 questions it sent to the various exchanges in April.

Tight Deadline

A delay was not unexpected. Almost from the day the Reg NMS rollout schedule was announced a year ago, brokerage execs condemned the June deadline as unrealistic.

However, the SEC, Shillman said, thought its dates reasonable. It had no clue, he stressed, of the extent to which the markets would try to reinvent themselves. It could not imagine it would someday have to sift through so many new business models.

At presstime, only the NYSE had received SEC approval for its revamp.

Nasdaq, the American Stock Exchange and the Chicago Stock Exchange have published their new rule-sets, but have not yet received SEC approval for the changes.