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Jared Dillian
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June 4, 2007

Block Traders Fret over New Rules

By Peter Chapman

Block traders, on the eve of full industry compliance with Regulation NMS' Order Protection Rule, are feeling queasy. On July 9, the third phase of the Securities and Exchange Commission's four-phase Reg NMS implementation plan kicks in.

On that date, broker-dealers will be responsible for complying with Rules 610 and 611 of Reg NMS, or the Access Rule and the Order Protection Rule, respectively, for 250 pilot stocks.

While many block traders say they are prepared for the changes, many others still have outstanding concerns.

As Traders Magazine was going to press, the Securities Industry and Financial Markets Association (SIFMA) was working with the SEC to iron out a set of frequently asked questions related to the order protection, or trade-through, rule.

At the top of the list for block traders was the question: "When is a trade a trade?" They need to be able to determine the exact time their block trade occurs. That then dictates which quotes they must take out when they want to print the block at a price inferior to those quotes.

Under Reg NMS, certain top-of-book quotes are protected from trade throughs. The obligation to hit those quotes rests with exchanges, but many broker-dealers are taking it upon themselves to hit those quotes with so-called intermarket sweep orders, or ISOs.

"We're still trying to understand when we put the trade up, what is the time of the trade," Matt Lavicka, a Goldman Sachs executive and SIFMA's point man for Reg NMS implementation, said at a recent SIFMA conference. "It matters because of what quotes you have to protect."

There are two schools of thought. The first holds that a trade is a trade when the broker-dealer trader verbally confirms price and quantity with his counterparty.

The second maintains it is not a trade until the trader gets his fills back on ISO sweeps. That way they know for how many shares they are at risk in the block trade.

The SEC was not expected to settle the debate, but could lay down guidelines for either case.

For some block traders, that issue is just a technicality. They have bigger concerns. One trader at a bulge bracket firm believes the new trade-through rule could drive him to conduct more trades after hours, when Reg NMS does not apply.

His concerns are two. First, he believes the requirement to take out any protected top-of-book quotes will cause him to tip his hand. "We will have to expose more of our risk to the Street," he said.

Second, the trader doesn't feel he should be forced to trade with those players in the public marketplace. He would rather they come in through his firm's front door.

"If there are large buyers working away, we want them in-house," he explained. "If we have to satisfy all the bids somewhere else, then the clients will stay where they are."

By trading after hours, the trader added, "we can trade with who we want. And we have a little more control over our risk."

Other traders aren't so worried about the impact of the trade-through rule. Jim Aniello, head trader at agency brokerage BTIG, for instance, notes that firms with sound, updated systems will be able to weather the coming changes.

They will have to have good systems, as the days of working in manual fashion are over.

"It's certainly a change in the way business is done," Aniello said. "And there will be some growing pains, but by now people should have their systems ready. This has been in the works for a year already."