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July 15, 2007

There's an Exception to Every Rule

This Time 13 is Lucky for Reg NMS

By Peter Chapman

Also in this article

The decision by the Securities and Exchange Commission last month to exempt two more types of transactions from Regulation NMS' Order Protection Rule. (See Rules & Regs section for details) brings to 13 the number of the rule's exceptions and exemptions. That's nine exceptions and four exemptions. Some are arcane. Some are likely to be used frequently.

The exceptions fall under Subsection (b) of Rule 611. The exemptions fall under Subsection (d). Traders Magazine summarizes them below.

The Order Protection Rule generally requires trading centers to take the necessary actions to avoid trading at a price inferior to another market center's immediately accessible best quote. That involves either (a) not trading or (b) simultaneously taking out the better-price protected quote. The term "trading center" can apply to exchanges, ATSs and broker-dealers.

The Exceptions

Intermarket Sweep Order (Incoming)

This exception makes it possible for a trading center, likely an exchange or ATS, to execute immediately any incoming order identified as an intermarket sweep order (ISO) even if a better-priced protected quote exists at another market center. Market centers are likely to receive ISOs from traders trying to fill their customers' block orders.

Intermarket Sweep Order (Outgoing)

This exception relates to the market center, likely a broker-dealer, transmitting the intermarket sweep order. It lets the broker-dealer execute an ISO at a price inferior to a protected quote. Brokers are likely to use these order types when printing blocks for customers away from the inside. The SEC will allow the broker to use the ISO as long as he simultaneously attempts to take out those better-priced protected quotations.


This one is already getting some use. The exception permits trading centers to fill orders at prices worse than protected quotes posted on other market centers if it appears those market centers are malfunctioning or taking too long to fill incoming orders. Taking more than one second to respond to an incoming order is too long under Reg NMS. A trading center making use of this exception must notify the non-responding trading center immediately after or at the same time as electing self-help. Nasdaq says it evokes the self-help exception three or four times per week. Other marketplaces accuse it of being "trigger happy," according to Nasdaq executives.

Benchmark Trades

Trading centers, most likely broker-dealers, may execute an order at a certain benchmark price such as volume-weighted average or market close without regard to better-priced protected quotes. These trades are often negotiated with institutional customers well before the price can be known and the trade is actually printed. According to the SEC, they are trades where "the material terms were not reasonably determinable at the time the commitment to execute the order was made." They are also "not priced with reference to the quoted price of the NMS stock at the time of execution."

Stopped Orders

Block traders will sometimes use stopped orders to guarantee a maximum or minimum price on a trade for a money manager. It gives the institution comfort to know it won't pay more than a certain amount when buying stock or receive less when selling.