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June 1, 2010

Industry Disagrees About 'Trade-at'

By Peter Chapman

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High-frequency traders, money managers and major exchanges want the Securities and Exchange Commission to propose some sort of "trade-at" rule. Broker-dealers that internalize retail orders and operate dark pools say it's a bad idea.

Joe Mecane

The SEC broached the idea of restricting off-board trading via a so-called trade-at rule in January, when it issued its Concept Release. The comment period covering the release ended April 21, and the votes--for and against--have come in.

"The Commission should consider the costs and benefits of a 'trade-at' rule," Gus Sauter, chief investment officer at money manager Vanguard Group, told the regulator.

"Knight strongly opposes the concept of a trade-at rule," wrote Len Amoruso, general counsel for wholesaler Knight Capital Group.

A trade-at rule, as envisioned by the SEC, would require brokers to send all their orders to the public markets and bar them from trading against, or "internalizing," those orders unless they took certain steps. The idea is just a suggestion at this point, but could, after industry debate, be crafted into a rule.

The concept stems from concern on the part of the SEC and certain industry players, including Vanguard, that too many orders are being traded away from the public markets. That, they fret, is impairing the price discovery process.

Under the SEC's trade-at idea, a broker could only internalize an incoming order if he maintained a limit order in that stock at the national best bid or offer. If he didn't, he could still internalize the order if he took one of two actions: (a) sweep all available limit orders that might otherwise trade against the broker's order or (b) price improve the order by the minimum tick. If he did neither, he would be required to route the order away.

If a trade-at rule came to pass, it would represent a dramatic change in the way business is now conducted. More order flow would find its way to the public markets. That would cut into the profits of large broker-dealers. It could also increase trading costs for their customers, the rule's detractor's argue. "This could represent a monumental and fundamental shift in the overall equities marketplace model," Chris Nagy, a managing director in charge of order routing, sales and strategy at TD Ameritrade, said at a recent industry conference. (Nagy is opposed to the rule.)

By and large, industry reaction is breaking down along predictable lines. Those organizations that would benefit from more flow reaching the public marketplace are in favor of a trade-at rule or something similar. Those who could see their businesses harmed are opposed.