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October 19, 2006

Trade-Through Exemption Set for Contingent Trades'

By Gregory Bresiger

Traders can ignore the Securities and Exchange Commission's new trade-through rule when executing a so-called "contingent trade."

That's the gist of a recent SEC order exempting certain qualified contingent trades from the Rule 611 trade-through provisions of the new Regulation NMS.

Contingent trades are those with two or more sides. Typically, they involve a stock and a derivative; a stock and another type of security issued by the same company; or the stocks of two different companies involved in a merger.

In other words, the successful trade of one security is contingent upon the successful trade of the other. Achieving that success can mean not altering the pricing dynamics of the marketplace.

The SEC granted the exemption on the advice of the trading committee of the Securities Industry Association. The SIA argued that contingent trades contribute to the stability of the marketplace, but would become an endangered species if traders had to comply with Rule 611 when handling them.

The SEC agreed, stating the two-part trade could become "too risky and costly to be employed successfully if they were required to meet the trade-through provisions."

Rule 611 generally prevents traders from executing their trades at prices inferior to those posted in the marketplace. They must first take out those better-priced quotes.

Doing so could change the economics of a contingent trade though. The transaction could be thrown "out of hedge" the SEC decided, making it less attractive to the broker-dealer.

Indeed, said Andy Madoff, an SIA Trading Committee member, the trade exemption was very important in protecting these kinds of trades

"Without the trade-through exemption, dealers would have been more hesitant to accept these kinds of trades," Madoff added. Trades would become too risky and costly for all concerned, he said. Customers would back off because dealers might be unable to commit capital, which would remove liquidity from the market.

Rule 611 is to go into effect in stages between February and October 2007.