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May 3, 2010

'Trade-At' Pits Exchanges Vs. Brokers

By John D'Antona Jr.

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  • 'Trade-At' Pits Exchanges Vs. Brokers

Call it the battle of the seen versus the unseen. The "trade-at" question in the Securities and Exchange Commission concept release pits the exchanges against brokers who internalize trades and other off board liquidity providers. In its Jan. 13 concept release, the SEC raised several questions about undisplayed liquidity's impact on price discovery. Trade-at is essentially a question about order handling and the routing of orders to the best price. It would shift liquidity from internalized sources, such as broker-dealer dark pools or other non-displayed liquidity providers, to the displayed markets.

Bill Harts

The subject hasn't exactly captured an endorsement from industry executives.

According to some, the clear beneficiaries of trade-at are the exchanges as their trading flows and fees should increase.

"Questions about market quality aside, this debate is really a market-share grab between brokers and exchanges," said consultant Bill Harts of Harts & Company. "The amount of order flow being internalized right now probably isn't large enough to affect price discovery. The SEC is taking a proactive approach by asking, 'What if it ever gets that large?'"

Many believe that the SEC is raising the question of whether or not internalization is bad for price discovery, the public markets and investors.

Trade-at is not a rule proposal at this time, but one of hundreds of questions the SEC has posed in its concept release to the industry, as it reviews how today's equities markets function.

Chris Nagy

If trade-at is formally proposed as a rule and passed, it would fall under Section 11A of the Securities Exchange Act of 1934. The SEC describes trading centers as exchanges, ECNs, over-the-counter market makers and dark pools. The SEC asks whether trade-at should affect them all or just some.

For example, such a rule would require "trading centers," including brokers, to route an order to the best price in the market, unless they are holding a limit order at that price. Of course, a trade-at rule would allow a broker to execute an order at a penny better than the national best bid or offer, giving an investor price improvement. But a broker wouldn't be able to execute a client order, or match, the best bid or offer in the market without price-improving.

Spokespeople at BATS Exchange and Direct Edge declined comment. However, both are in the process of submitting comment letters to the SEC. Calls for comment from NYSE Euronext and Nasdaq were unreturned.