Tim Quast
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We're All HFTs Now

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June 4, 2007

Trade Throughs Unlikely to Disappear under Reg NMS

By Peter Chapman

Best-ex trumps Reg NMS. Traders are vowing to place best execution ahead of the dictates of the Securities and Exchange Commission's Regulation NMS Order Protection Rule despite any possible consequences.

The new rule goes into effect for broker-dealers on July 9. It could leave traders faced with a choice of either acting for the benefit of their customers or complying with the rule, traders complain.

It will, they say, take away some of the flexibility they have in filling orders. That's because they will be forced in some cases to sweep the tops of market centers' books rather than trade multiple levels on one market center.

So they may ignore the rule and trade through the so-called protected quotes anyway. "Traders will get their customers the best prices they can," Andy Madoff, co-head of trading at Bernard L. Madoff Investment Securities, said, "and invariably that will sometimes lead to trading through a quote they believe they can't access."

If they do so, traders may be able to take some comfort in the fact that the new trade-through rule is a "patterns and practices" rule. In other words, the SEC will not penalize them for every violation.

Sources say the SEC has been pointing out this fact regularly in recent months. "The SEC has been very clear about this," said Michael Rosen, an executive with Los Angeles-based agency brokerage UNX. "Reg NMS does not obviate your obligations as a broker for best execution."

That the rule is a "patterns and practices" rule was no accident, Rosen explains. "The SEC realized if they set up a bunch of inviolate rules, they would end up with a non-functioning market."

Many traders are still wary though. "The SEC has said repeatedly it is a patterns and practices rule and that we will not be expected to answer on a trade-by-trade basis for apparent violations," Madoff said. "And as long as that is what they stick to in their surveillance and enforcement, then it will be fine. But people are skeptical."