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July 1, 2010

Out of the Dark

Traders Give Proposed Trade-At Rule Thumbs Up

By John D'Antona Jr.

On Friday, April 23, at 10:19:35 a.m., Dennis Dick posted a limit order to sell 100 shares of Royal Bank Scotland at $14.04 on the New York Stock Exchange. Exactly 25 hundredths of a second later, a trade was executed in a dark pool at $14.0399. Dick's limit order sat unexecuted.

Dennis Dick, Bright Trading

The veteran proprietary trader lowered his offer to $14.03, only to see the stock trade at $14.0299 five hundredths of a second later on Nasdaq's trade reporting facility. This pattern--of Dick lowering his offer, and trades printing on the TRF--went on for several minutes until, in exasperation at not getting filled, Dick withdrew his offer and moved on to another trade.

And so began another frustrating trading day for Dick, who feels he is fighting an uphill battle against broker-dealers who internalize orders that would otherwise interact with his in the public markets.

"This is predatory market making. This isn't an isolated event. These events happen continuously every day in this two-tiered market structure," said Dick, who thinks the current setup is unfair for investors. "Our regulators need to deal with this immediately."

Dick's complaint is that current market regulations make it too easy for brokers to not send their orders to the exchanges. He champions an idea brought up in the Securities and Exchange Commission's Jan. 14 Concept Release known as a "trade-at" rule.

If implemented, a trade-at rule could result in a much higher number of orders sent to public markets than today. That in turn would result in many more limit orders getting filled, which would support the SEC's long-term goal of encouraging traders to post limit orders on public books.

Dick, an 11-year trading veteran and prop trader at Nevada's Bright Trading, said he and his firm's 400 fellow traders are increasingly finding their limit orders ignored as so-called internalizers trade against the orders themselves, often filling the orders at prices only marginally better than the national best bid and offer.

In January 2008, 18 percent of equities trading volume was executed off-board, according to a recent research note from Macquarie Group. This January, the number reached 31 percent.

As envisioned by the SEC, a trade-at rule would require "trading centers"--including brokers--to route an order to the best price in the market, unless they are holding and have posted a limit order at that price.

If the broker isn't in the market with a limit order equal to the NBBO, he must do one of two things. If he wants to internalize at the publicly displayed price, he would have to first sweep the book and take out all those limit orders


Two Tiered Market System