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NYSE Tries Again for Sub-Penny Pricing

A proposal submitted by NYSE Euronext this week to the Securities and Exchange Commission marks the second time in the past two years the exchange operator has looked to sub-penny pricing to gain an advantage over brokers in the trading of retail orders.

The New York Stock Exchange has asked the SEC for approval to allow a special group of "retail liquidity providers" to quote between a stock's best bid and offer in increments of two-tenths of a cent. The quotes would be hidden from view and only accessible by providers of retail order flow.

The upshot would be to provide the retail customer with better pricing than is visible on exchange books, a service now provided by wholesalers and other brokers that internalize their orders.

The proposal marks the second attempt by NYSE to quote in sub-pennies as a way to compete with wholesalers. Last year, NYSE and two other exchanges wrote a joint letter to the SEC requesting the ability to trade in sub-pennies in certain low-priced stocks. The SEC did not approve the request.

Currently, brokerages are allowed to price their merchandise in sub-pennies, but exchanges are not.

There has been some debate over the use of sub-pennies in recent years as spreads in many stocks have narrowed to a penny. Some trading officials contend that a penny increment may be too high for some securities.

"What is the natural tick increment at which stocks should trade?" Joe Mecane, an NYSE Euronext executive vice president, asked rhetorically at the Security Traders Association's annual conference Thursday. "This has been subject to debate since the SEC released its Concept Release."

The NYSE proposal calls for using hidden, not displayed, quotes. That contrasts with the proposal in the letter sent by NYSE, Nasdaq OMX, and BATS Global Markets last year to the SEC that called for using displayed quotes.

"Why not do this in displayed fashion and put them on the SIP feeds?" Chris Isaakson, BATS' chief operating officer, asked at the conference.

Besides the issue of transparency, the proposal is likely to impact the ongoing debate over a trade-at rule. The SEC is mulling a rule that would push wholesalers to offer more price improvement to their customers. The brokers have complained such a rule would kill their business.

The SEC is worried that not enough flow is making it out of brokerages' trading departments and to the public markets. Giving exchanges the right to trade in between the spread could take the pressure of the wholesalers.

That would "certainly move the trade-at discussion in a different direction," Mecane said.

Chris Nagy, a managing director at TD Ameritrade, one of the largest retail brokerages, contends the proposal, if approved, could diffuse the trade-at issue.
"It won't be the demise of internalization," Nagy told Traders Magazine. "But it's a very elegant solution for trade-at."