Fidelity’s Roiter Sees Reg. NMS Benchmark Order Exception as Alternative to Opt-Out
Now that the opt-out provision has been left on the Reg. NMS cutting room floor, are you concerned about getting your large orders done? Regardless of how the Commission comes out on the depth of book or top of book options, it looks as though there will be at least two options in the final version of Reg. NMS for getting block orders done quickly and quietly: the intermarket sweep exception and the benchmark order exception.
Speaking at last week’s American Enterprise Institute’s conference on Reg. NMS issues, Fidelity Management and Research general counsel Eric Roiter said that Fidelity is "attaching a great deal of importance" to the latter. After studying the benchmark order exception and talking to the staff of the Division of Market Regulation, "we’re of the view that there is a potential here for the benchmark order exception to serve as a de facto or a functional equivalent of an opt-out."
The benchmark order exception (found at paragraph (b)(7) of proposed Reg. NMS Rule 611), provides that the general trade-through prohibition does not apply to the execution of any order "at a price that was not based, directly or indirectly, on the quoted price of the NMS stock at the time of execution and for which the material terms were not reasonably determinable at the time the commitment to execute the order was made."
The SEC’s December 2004 reproposing release explains that a common example of a benchmark order is a VWAP order. So, for example, say a fund places an order for 100,000 shares of XYZ Inc. at VWAP from opening to 1:00 pm. At 1:00 pm, the VWAP for the period turns out to be $19.90. The best bid and offer, however, is 20.00. However, in reliance on the exception, the broker is free to buy XYZ at 20.02, says the release.
But what if VWAP isn’t good enough?
"Notwithstanding the example that is given in the release about doing a trade at VWAP," Roiter told the AEI audience, "the formulation of the benchmark order exception is written in more flexible terms that would allow us, for example, to negotiate around a benchmark, around VWAP." To realize "the economies of scale that we are supposed to realize" for Fidelity’s fund shareholders, "we can actually apply that in trading itself, if we are able to negotiate a block-sized purchase at VWAP minus, for example, 6 cents . . . or negotiate a block-sized sale at VWAP plus 5 cents." That, he pointed out "is better than VWAP."
"It’s clear to me that the language as written will allow that," Roiter added. He said that it was "extremely important" to Fidelity that the benchmark order exception "be retained as flexibly as it has been expressed in the reproposing release." The test under the proposed exception, he said, is that "no one can tell you a dollar-specific price at the time the deal is agreed to with the upstairs broker." Or, put another way, as long as the ultimate price paid is one that is dependent upon factors that are outside the immediate control of the parties to the trade and don’t turn on the price of the stock at the time the trade was executed, "you’re free to negotiate a block-sized trade even though at the time of its execution, there will be limit orders traded through," said Roiter. "The SEC, I think, did a credible job of explaining that this was in recognition of competing interests, [namely,] the interests of those who do leave limit orders on the books of market centers and those who seek to avoid market impact costs in doing large block trades."