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SEC opens NYSE access
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December 8, 1999: 5:59 p.m. ET
Regulators approve trading of Big Board stocks to include pre-1979 listings
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - The Securities and Exchange Commission adopted a rule Wednesday that expands access to trading in New York Stock Exchange stocks for non-NYSE members.
The new rule, which will go into effect in 60 days, eliminates what the SEC in a release called "an artificial barrier to trading.” It aims to increase competition between stock markets and to foster better prices and execution of trades for investors.
For 20 years, the New York Stock Exchange has required that any stocks that first listed on the NYSE prior to 1979 trade only on an exchange, a policy known as Rule 390. But last week the NYSE board voted to rescind the rule, which SEC Chairman Arthur Levitt had criticized as anachronistic and anticompetitive.
"I commend the NYSE and Chairman [Richard] Grasso for this important step in the direction of more competitive markets,” Levitt said.
During an open meeting in Washington, the SEC approved the trading amendment, which will have the most effect on Nasdaq -- which is technically a stock market but not an exchange -- and its market-member firms that trade listed stocks off an exchange. Now Nasdaq members will be able to trade all NYSE-listed stocks.
Nasdaq spokesman Scott Peterson said, "We applaud the SEC’s announcement ... The NASD has been asking for the repeal of this anticompetitive NYSE regulation for almost 20 years. By eliminating this rule, investors large and small will benefit from the marketplace that soon will be even more price competitive than it is today.”
Greater access through ITS
The new rule approves access to those stocks for non-exchange members through the Intermarket Trading System (ITS) and its Computer Assisted Execution System (CAES), which links Nasdaq to the ITS.
Previously, many of the NYSE’s large-cap issues, such as General Electric and IBM, had been off-limits to Nasdaq members. But, members of the NYSE and the regional exchanges could trade all listed stocks and make contact to each other through ITS.
ITS is an electronic order-routing system linking Nasdaq -- through CAES -- with the exchanges and it links the exchanges with each other. Using ITS, an order on one exchange can be routed to a better quote elsewhere. Nasdaq’s equivalent is called SelectNet.
As part of the announcement that it had approved greater access to the ITS for Nasdaq market makers, the SEC also said it hopes to improve access to listed stocks for Electronic Communications Networks, or ECNs. The nine ECNs are quasi-exchanges that let buyers and sellers of stock meet electronically without the use of middlemen such as market makers and specialists. Keeping overhead low and executing trades quickly and cheaply, they already complete a third of the trades on Nasdaq.
"Our markets simply cannot afford to have progress towards faster, better linkages impeded,” Levitt said at the meeting. "In particular, investors are demanding and deserve a linkage between ECNs and the listed market, and we intend to work expeditiously to ensure that such a linkage materializes shortly.”
The ECNs are technically broker-dealers and members of Nasdaq. By becoming market makers, they could link to ITS through Nasdaq, but ECN executives said they think the access would be of limited use. Instead they are pushing for direct access, and several have filed for exchange status to get that.
New rule gets mixed reviews
The new rule received mixed reviews from many in the investment community.
"We believe that the initiative is positive for both established markets and emerging trading systems,” Ray Pellecchia, an NYSE spokesman, said. "Most importantly we believe that it benefits the investing public.” Competition between markets is healthy, he added, though regulators must ward against market fragmentation.
Bernie Madoff, who heads Bernard L. Madoff Securities, a major market maker, applauded the rule change. "Obviously it will create more competition between the regionals [exchanges] and NASD,” Nasdaq’s parent, he said. "I think it’s a very positive move for the third market in general.”
But, he pointed out that some market makers have access to all NYSE listings by virtue of being a member of a regional exchange, Cincinnati Stock Exchange in his company’s case. So the effect is limited. Still, "390 is down, and that will allow more trading in general by New York Stock Exchange members, who can make markets and trade against their own book,” he said.
Pat Healy, president of The Issuer Network and a consultant on stock markets, pointed out that Rule 390 covers some big names, but that the impact is less than you might expect at first blush. "That population comprises significantly less than a third of the NYSE trading volume,” he said.
Although he said the rule change "isn’t a horrible thing,” he said he is not sure it will lead to better trading for investors. Because orders on listed shares will no longer be required to go to the floor of an exchange, he said investors may miss out on a floor dealer improving the price. For instance if a stock is trading at 30 on the bid and 30 1/8 on the offer, "who’s to say it couldn’t have got matched at 30-1/16?” on the floor, he said.
If the trades are completed within a Nasdaq market maker without going to the exchange, investors miss out on that opportunity for price improvement. He said he does not think spreads will improve as a result of the SEC’s rule change, either, and that the change opens the door to payment for order flow, where a market maker pays brokerages to have trades routed its way.
On the same example, a market maker such as Madoff, which he called the "king of order flow,” may pay 2 cents to the brokerage for a $30 bid to send the trade its way and pay 2 cents to the brokerage with the offer at 30-1/8 to do the same. The market maker profits from the spread of 1/8, or 12.5 cents. Such payments for order flow are not illegal but they do not benefit investors, Healy said.
In general, competition between markets is positive for investors, though, Healy said. He thinks the main effect of allowing Nasdaq market makers access to Rule 390 stocks is that the NYSE will now start to compete for trades in Nasdaq stocks, something the Big Board does not do at all at the moment. Healy also said he expects the NYSE to form its own Electronic Communications Network, or ECN, in the near future to compete for cheap, electronic trade execution.
Barbara Roper, director of investor protection for the Consumer Federation of America, said she welcomes competition between stock markets. But as trading becomes more splintered or fragmented between various stock markets, regulation becomes tougher to enforce and issues such as "best execution” of trades becomes more complicated.
For instance, price improvement may not be the only reason for routing a trade to a particular stock market, particularly if the price difference between stock markets is minute. That will apply all the more when the stock markets move to decimal pricing next year.
Speed and reliability of execution and the cost of executing a trade can also matter if the price difference is very small, she said.
Since one of the main attractions of the NYSE is that it is already very liquid, "it’s hard to say the competition will do much to narrow spreads,” she said. "But who knows? It [allowing access to 390 stocks] was certainly the right move to make,” she added. "It was an anticompetitive, outmoded rule. And we certainly agree that it’s time to go.”
Improved ECN access?
Although technically ECNs have been able to trade listed stocks such as AOL that moved to the Big Board after 1979, none do, said Cameron Smith, chief counsel with The Island ECN. That will not change even now they will technically have access to the pre-1979 listings, either, he said.
"The proof would be in the pudding,” he said. Island will soon offer trading in listed stocks to its members, he said. But the utility is very limited because ECNs are not part of the Consolidated Quote System that provides one quote for listed stocks. Only exchanges participate in the listed-stock quote system. (Nasdaq has its own quote system).
That means that price quotes on an ECN for listed stocks only appear to members of that ECN. They are not displayed to members on the NYSE floor nor are they included in quotations of listed stocks that quote vendors distribute. So even if an ECN had a better price on a stock, only its members would know that.
"We’re able to open up a restaurant. But we can’t put a sign out front or otherwise advertise,” Smith said.
What is more, the ITS link is technologically outmoded and the rules for using it are not suited for electronic trade execution, Smith said. For instance, the response time through ITS is anywhere from 60 seconds to two minutes, he said, compared with 0.004 of a second for Island. Many of the ITS rules, which were written in the ‘80s, "are really geared toward human intervention,” he said, while Island and the other ECNs execute trades automatically.
As a result, even Instinet, the only ECN to do any significant volume in listed stocks, executes the trades on listed stocks internally, with other Instinet members. Much of the volume in listed stocks on Instinet is also after-hours trading, when the NYSE is closed and Instinet is the only avenue for trading listed stocks.
ECNs account for the majority of after-hours trading. The retail brokerage E*Trade links to Instinet and offers after-hours trading in NYSE stocks. But no other brokerages link to Instinet - the agreement is exclusive for a limited time - and no other ECNs offer after-hours trading in NYSE stocks. As a result, the SEC rule change will likely not ease after-hours trading in NYSE listings for individual investors.
But, the SEC suggested that improved ECN access to listed stocks is a priority. It’s a priority the ECNs welcome.
"This is a nice first step, and we certainly applaud the SEC urging the New York Stock Exchange to repeal 390,” Smith said. "We’re certainly in favor of anything that enhances competition and the removal of unnecessary barriers. But this doesn’t have a dramatic impact on our business.” 
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