SEC Adopts Reg NMS Amidst Change in Leadership

Reg NMS was adopted by the Securities and Exchange Commission yesterday despite a change in the top leadership at the regulatory body.

The final rule was published June 9 on the SEC's Web site and will take affect in two phases: Phase I will begin June 9, 2006 with a set of 250 stocks. After nine weeks, Phase II will begin with all national market system (NMS) stocks.

The SEC voted to pass Reg NMS on April 6 in a 3-2 vote, with Chairman Donaldson voting along side the two Democratic commissioners. However, the resignation of SEC Chairman William Donaldson last week triggered speculation over whether the new chairman would review the rule before allowing it to be published.

Last Wednesday Donaldson said he plans to step down as SEC chairman by June 30. President Bush nominated Rep. Christopher Cox as the new chairman of the SEC, who reportedly has a more business-friendly and anti-regulation stance.

Prior to seeing the final rule published yesterday, there was speculation over whether the entire package of market-structure rules, especially the trade-through rule - which requires brokers and market centers to obtain the best price for a client's order - could be overturned?

"I think the wholesale repeal of what's already been decided is unlikely," says Sang Lee, managing partner at Aite group, a Boston-based financial advisory and research firm.

Instead of repealing the rule, Lee believes the new commissioner may look at a more gradual rollout process, as opposed to a wholesale implementation in 2006.

"I don't know what the politics are going to be. I don't know if Cox is going to do anything or not," says Junius Peake, Monfort Distinguished Professor of Finance at the University of Northern Colorado's Monfort College of Business. But Peake, a veteran watcher of market structure debates, notes the SEC has spent a year and a half on Reg NMS, which goes into effect next summer, and it still has to approve the New York Stock Exchange's Hybrid Market plan.

Industry sources say the details of Reg NMS could be subject to review.

"It would be prudent for the new chairman to review the proposed final rules in depth before they're published," says Michael Richter, executive vice president, business development at Lime Brokerage, a New York-based agency broker that provides direct-market access to equity markets. "And so until he's confirmed at all I would expect that might have some delaying impact in publication of the final rules," adds Richter.

But if Reg NMS is delayed, that could impact the New York Stock Exchange's proposed Hybrid Market, which also has yet to be approved by the SEC.

"The NYSE is talking about the early spring for the final stages of the Hybrid functionality being available," says Joseph Gawronski, chief operating officer at Rosenblatt Securities, an institutional agency broker that is also an NYSE member. "That's a challenge in itself. But if Reg NMS isn't published soon and the final remaining Hybrid amendment approved quickly by the SEC, and if a new commission comes in and says - it has to review everything from scratch," that uncertainty could conceivably add another year onto the schedule, delaying the "fast quote" market that many customers have lobbied for, says Gawronski.

"Do we really want to open up the whole trade-through can of worms again? Do we really want to take an extra year to see the Hybrid implemented?" asks Gawronski, noting that Reg NMS is not scheduled to go into effect until next summer as is.

But Gawronski says it ultimately may not matter much either way if the trade-through applies to Nasdaq-listed stocks since all the major electronic communications networks (ECNs) have adopted smart-order routing, and "that's essentially what Reg NMS is." If an ECN can't match an order internally, it routes it out to the market that has the best price, which is what Reg NMS would require of it, he says.

One of the reasons that may have delayed the final rule from being published is that certain details in the trade-through rule are contradictory to an extent, says Aite's Lee.

Lee says the so-called order-protection rule (a.k.a., trade-through rule) only applies to the fast market, but not the floor or slow market. "But what happens if the best price is on the floor?" asks Lee. According to the order-protection rule, participants can bypass a slow market (manual price) but the order protection rule also states that participants shouldn't bypass the best prices. So there's an inherent contradiction," says Lee.

As a result, Lee contends that many industry participants "don't know what they are expected to do," to comply with Reg NMS.

Lee says the industry is looking for some clarification and finality. "If the new SEC chairman repeals it, then he has to have another idea of how to fix the market structure," says Lee. "Simply repealing it, doesn't do anybody any good," he says. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio