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SEC Proposes New Trading Regulations

Markets: Rules would tighten for 'alternative' systems, free up exchanges to better compete.

April 17, 1998| From Reuters

Federal regulators Thursday proposed new regulations for independent electronic trading systems, setting new reporting requirements for these growing systems that compete directly with traditional exchanges.

At the same time, the Securities and Exchange Commission proposed easing some of its rules governing exchanges, allowing them to innovate and compete more freely with these so-called alternative trading systems.

"By keeping the regulatory framework flexible enough to accommodate changes in a fast-moving environment, we will help protect market integrity and strengthen investor protection," SEC Chairman Arthur Levitt said.

Current independent systems include Reuters Group's Instinet, Bloomberg's Tradebook, Terra Nova Trading and Island.

The SEC said these types of systems, which typically allow institutional investors to trade directly with one another, now account for about 20% of trades in Nasdaq stocks and 4% of transactions in exchange-listed securities. The proposals would not apply to brokerage in-house proprietary systems or to electronic systems used in U.S. bond trading.

Under the proposals, the independent trading systems, of which there are now about 50, could continue being regulated as broker-dealers. But higher-volume systems would have to disclose information about customer orders to the market overall.

As an alternative, these systems could opt to register with the SEC as an exchange and comply with a host of new standards.

"Our proposal today recognizes that technology has blurred the lines between broker-dealers and exchanges," said Richard Lindsey, director of the agency's division of market regulation.

High-volume systems opting to remain broker-dealers would have to display certain orders publicly. Once a system reached 10% of trading volume in a security, it would be required to disseminate the best-priced orders on that security, including institutional orders, into the public quote stream.

When trading in a particular security on an electronic system hit 20% of the security's total trading volume, the system would have to prove to the SEC that it had adequate capacity and security.

"This is intended to prevent the system outages--and resulting disruption to the market--experienced by some alternative trading systems during heavy trading volume," the agency said.

Low-volume systems taking the broker-dealer approach would be required to make quarterly reports to the SEC with standard exchange-like audit-trail information.

The agency has also proposed offering some relief to exchanges that cannot always compete with these high-tech, investor-to-investor trading systems.

The SEC separately is proposing that exchanges be able to list and trade new derivative securities products without approval. Exchanges that already trade a certain type of option or derivative would be able to list similar products without the SEC's approval.

The proposal could be crucial for the Chicago Board Options Exchange, American Stock Exchange and Pacific Exchange, all of which specialize in derivatives.

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