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News April 18, 2005 Issue

Congress to Step in to Reg. NMS Fray?

As expected, the SEC adopted Reg. NMS by a 3-2 vote on April 6. The rulemaking provides top-of-book trade-through protection, applicable to NASDAQ as well as the exchanges. It does not contain an "opt-out" exception.

Compliance with the new trade-through rules will begin with a small group of representative stocks. The first phase will begin on April 10, 2006 and end on June 9, 2006. On June 12, 2006, trading centers will be required to begin trading all NMS stocks pursuant to the top-of-book trade-through rule.

Reg. NMS also contains rules that promote non-discriminatory access to quotes displayed by SRO trading centers through private linkages. In addition, it contains a new rule prohibiting sub-penny pricing, something that plagued institutional investors following decimalization of the securities markets. The compliance date for the sub-penny rule is July 1, 2005.

In his remarks at the SECís open meeting, chairman William Donaldson emphasized that the adoption of Reg. NMS was preceded by years of study by the SEC staff. He noted that some critics of the rule have "couch[ed] their arguments in free-market principles that, at an abstract level, are easy to agree with." Although he acknowledged that a market-led solution has "superficial appeal," he said such an argument downplays issues such as the persistence of conflicts of interest, free-riding, and unequal bargaining power among different kinds of investors. While the SEC considered the free market point of view, he dismissed it as a "sweeping and indiscriminate proposition," adding that "public policy in this country has for more than 70 years taken a much more nuanced approach."

And what does one of the leading proponents of the free market perspective have to say?

"I think everything I had said before the meeting is sort of a response to that," said Peter Wallison of the American Enterprise Institute. In his view, "there isnít any basis for regulation unless you can point to some failure in the way the system is operating without regulation." Donaldsonís arguments "were basically fallacious" and "do not stand up to analysis," said Wallison. "I donít know why he accepted those arguments and why he insisted on putting this forward. It was a little sad to see him arguing on behalf of the trade-through rule on the basis of this data."

Wallison agreed that ITS wasnít functioning in the way it was intended: "You had to change ITS." But in his view, there wasnít "any basis" for having a trade-through rule. Simply because the SEC "wanted some kind of change" at the NYSE shouldnít have led the SEC to apply the trade-through to NASDAQ, he said. It would have been a "perfectly acceptable approach" to apply the rules that the SEC thought were necessary only to the NYSE and "leave NASAQ alone," unless there was some data showing that NASDAQ wasnít functioning effectively, he said. And, according to Wallison, everyone who deals with NASDAQ agrees that it works "perfectly well" without any trade-through. Even people who support the trade-through rule primarily because they want to be sure that the NYSE was reformed acknowledge that trade-through is not necessary for NASDAQ, Wallison added. However, their attitude seems to be, "If thatís the price of getting changes at the NYSE, Iíll accept it," he said.

Wallison wasnít the only one voicing strong opposition. Commissioners Cynthia Glassman and Paul Atkins filed dissents, with Atkins urging Congress to step in. "I would encourage our oversight committees in the Senate and House of Representatives to take up this cause explicitly and set us straight," he said. "It is time for Congress to give us clear, modern direction, so that we can stop looking longingly backwards and enter the 21st Century."

Atkins might get his wish. Shortly after the SECís meeting adjourned, Senator Michael Crapo (R-ID), who sits on the Senate Banking Committee, expressed his displeasure. "I am disappointed and troubled that the Commission was unable to proceed with one voice on this important rule," said Crapo. The lack of consensus within the SEC, academia, and industry "raises the possibility that Congress should intervene," he said. "There appears to be growing support for congressional action at this point and I am evaluating all options including legislation to address this matter."

On the House side, Representative Richard Baker (R-LA), who chairs the House Capital Markets subcommittee, released a post-meeting statement of his own: "I fear that we have just witnessed a horrible step toward making our free market system substantially less free," said Baker. "The trade-through rule at the NYSE is an anticompetitive relic that robs investors of choices, and it should have been eliminated. That the SEC instead decided that the fair solution to this problem is to extend the trade-through rule to other markets, against their will and the wishes of investors, is simply incredible. I have no choice but to begin taking my own steps, which may include legislation, to undo the harm I believe this rule will inflict."

So whereís this anti-Reg. NMS bill weíre hearing so much about?

"We canít do anything until [Reg. NMS] has been printed in the Federal Register," explained Susan Wheeler, Crapoís communications director. "Thatís not to say we have a bill ready to go," she added. "There hasnít been a decision as to where [Senator Crapo] wants to go with it at this point."