TCS Daily

Foolish Haste on Stock Trades

By James K. Glassman - December 2, 2004 12:00 AM

What's the rush?

That's the question baffling investors as the chairman of the Securities and Exchange Commission prepares to push through what the Wall Street Journal calls "an overhaul of rules that could radically alter the way billions of shares trade each day in the U.S."

Yes, "radical" is the word. We would add "reactionary," too.

Incredibly, the public is not being told what's in the proposal for the first major changes to the National Market System (NMS) in nearly 30 years. SEC Chairman Bill Donaldson is keeping the plan under wraps, probably up until the day of the vote, set for Dec. 15. What's certain, however, is that the plan limits choice and competition.

With President Bush re-elected and Republican seats in Congress augmented, you might think that the SEC would be liberating, along free-market lines, the overly complicated and highly regulated process, called NMS (National Market System), that turns an investor's request to buy or sell shares into a trade.

But you would be wrong.

Donaldson, steeped in the tradition of the Wall Street establishment, has consistently favored top-down rules, supported, not by empirical evidence, but by what he and the two Democrats on the commission think is right for investors.

In fact, the best way to find out what's right for investors -- or consumers of any sort -- is competition, which, as the Nobel economist Friedrich von Hayek once said, is "highly conducive to the achievement of many different individual purposes not known as a whole to any single person, or relatively small group of persons."

Competition "discovers" the answers to complex questions, typically by providing consumers with broad choices -- rather than having government make a one-size-fits-all selection.

Technology recently intensified competition and choice in the stock-trading arena, and speedy electronic markets run by Nasdaq and ECNs like Instinet have given the New York Stock Exchange a run for its money.

But the NYSE has regulatory protection for its own listed stocks through something called the "trade-through rule" -- the effect of which is to route transactions to the anachronistic NYSE floor (with its specialists and their notepads) whether investors want to go there or not.

The obvious next step would be to eliminate the trade-through rule for NYSE stocks, or allow investment firms to opt out on behalf of their customers. But, amazingly, Donaldson and the SEC staff instead want to extend the rule to Nasdaq stocks.

Reg NMS, as it's called, will have a profound impact on America's 100 million investors, small and large, and the sensible course is to air the proposal fully. Unfortunately, it could turn out that the only way to get the airing is through a lawsuit claiming that the SEC is violating the Administrative Procedures Act. There's a good case.

But why should average Americans care about all this arcane stuff?

First, an extension of the trade-through rule would give investors fewer choices when it comes to executing a trade. Many investors prefer speed, certainty and secrecy over the chance that they may get a better price on the NYSE floor (often that price turns out to be "stale").

"I liken this to the 'bird in the hand, two in the bush' concept," said the SEC's Cynthia Glassman (no relation), in a September speech. Glassman has argued that NMS needs more debate, and she and the other Republican commissioner, Paul Atkins, are likely to oppose the changes in a rushed vote.

Second, Donaldson is rejecting efficient market-oriented solutions - in a pattern that has become depressingly familiar, in both Congress and the regulatory agencies, since Enron filed for bankruptcy three years ago this week.

The flood of ill-considered regulations that followed has mainly hurt, not helped, small investors by depleting the worth of their holdings A recent study by Korn/Ferry found that the average Fortune 1000 company would spend $5.1 million this year alone complying with the Sarbanes-Oxley law. If you apply the current average price-to-earning ratio of 18, investors will lose about $90 billion.

Meanwhile, CEOs are spending more time on green-eyeshade nitpicking than on running their businesses. The new regulations, which Yale University scholar Roberta Romano appropriately calls "quack corporate governance" (because, like Reg NMS and other SEC rules, they ignore actual research), are especially dangerous at a time of increased competition from Asia. America's competitive advantage in strategic corporate risk-taking is being eroded.

Meanwhile, however, risk-taking thrives at the SEC -- which is just where we don't need it. Slow down!


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