 Commentaries
 Printable Version |
 Email to a friend
|  Download PDF file 'OPED0409_tradethrough.pdf'
Taking Stock of the Trade-Through Ruleby
Tad DeHaven Sep 14, 2004 In another example of why Republican control of Washington's corridors of
power does not guarantee less government or freer markets, SEC Chairman William
Donaldson recently cast deciding votes in favor of yet more burdensome regulation
of the economy--on the issues of mutual fund management and hedge funds.
Most market watchers and economists agree that the new edicts will probably
have little benefit beyond the assuaging of over-zealous regulatory minds
at the SEC. Instead, the new hyper-regulations will lead to increased costs,
inefficiencies, and a reduction in the capital accumulation that provides
vital fuel for our economy.
Now Donaldson's SEC is considering extending 1970s-styled "trade through" rules
from the traditional securities exchanges such as the NYSE to the over-the-counter
market of NASDAQ.
The trade through requirement for NYSE listed securities, which has been
in place since the Nixon years, requires an order to be routed to a better-priced
market regardless of how long it will take to be executed. There is also
no guarantee that when the order is finally completed the investor will get
the price that was advertised. In fact, the risk exists that the order will
not be filled at all.
Forcing orders to be routed to a slower, manual market such as the NYSE
decreases efficiency and can undermine a broker's duty to obtain the best
execution for the investor. While the trade through rule already in place
for listed securities supposedly protects investors from inferior prices,
it actually serves as monopoly protection for the outdated and rapidly aging
manual market and its system of specialists.
On the other hand, the trading of NASDAQ securities occurs in an automated
environment that does not have a trade through rule. Thus investors are offered
faster executions and better overall pricing. Even though NASDAQ securities
are not currently "protected" by a trade through requirement, there has been
little complaint from the investing public that appropriate prices are not
being obtained. After all, investors are protected by the broker-dealer's
obligation to deliver the best trade for its customers.
Many interested parties have framed the debate as being a black-and-white
question of whether it is more important for the investor to receive the
best price or the quickest execution of the trade. But this would be a misrepresentation
of reality. Securities subject to trade through rules do not always end up
actually getting the "best" price and they certainly do not receive the most
expeditious execution. On the other hand, securities not subject to trade
through rules do tend to get the overall best price, due in large part to the faster trading
nature of the less regulated automated market.
Perhaps a 'real' world example is in order. Let's suppose an individual
is selling his car and receives two offers. The first potential buyer offers
$10,000 in cash while the second buyer offers $10,500. However, the second
buyer's offer is contingent upon his ability to secure a loan from the bank.
It is not automatic that the seller will choose to accept the second buyer's
offer even though it is for an extra $500. Why? Perhaps the seller needs
the cash upfront and doesn't want to risk the bank rejecting the second buyer's
loan. The key is that the seller should have the choice of deciding which
of the buyers gets the sale.
Let's now suppose that a trade through type law exists which forces the
seller to take the second buyer's offer. It is very possible that the second
buyer might not be able to secure the loan and thus cannot purchase the car.
Or perhaps he ends up only being able to come up with $9,500 to offer the
seller. Thus the seller could be facing a situation where he would have been
better off without a forced trade law. Although it is unlikely that such
a law would exist in the used-car world, this is precisely the effect that
trade through rules have in the securities market.
So, despite the complexities, technicalities, regulations and arcane terms
that permeate the securities industry, the issue basically boils down to
one of choice. Crusading regulators "looking out for the little guy" would
be wise to consider the unintended consequences of their actions.
Let us hope that Chairman Donaldson discovers the virtues of competition,
deregulation, and technological change. Voting to remove trade through rules
or allowing investors to opt-out of them would be a welcomed move in that
direction.
###
Tad DeHaven is an Economic Policy Analyst with the 350,000-member National
Taxpayers Union (www.ntu.org), a non-partisan citizen group founded in 1969
to work for lower taxes, smaller government, and more accountability from
elected officials at all levels. |
