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To: TFF who wrote (11260)	6/1/2004 2:37:17 PM
From: TFF	Respond to of 12617

US SEC mulls order flow reforms for options market Fri May 28, 2004 02:51 PM ET Printer Friendly \| Email Article \| Reprints \| RSS (Page 1 of 2) Top News Judge Rules Against Partial-Birth Abortion Law U.S. Gives Unqualified Support to New Iraq Leaders Iraqis, U.S. Cut Deal on President as Bombers Strike MORE By Kevin Drawbaugh and Doris Frankel WASHINGTON/CHICAGO, May 28 (Reuters) - Market regulators are looking at three possible strategies for tackling a problem in how customer orders get routed to different exchanges in the $725-billion U.S. options market. Known as the "payment for order flow and internalization" problem, the issue raises questions about brokers' duty to get the best price for clients, say critics of the current system. Payment for order flow occurs when brokerages are paid by trading specialists or exchanges to steer orders their way. Internalization is when a brokerage firm takes the opposite side of a customer's order. "Both practices ... are out-and-out violations of a broker's fiduciary responsibility to his customer," said Joshua Parker, president of Gargoyle Asset Management, a New Jersey-based options firm. The Securities and Exchange Commission "must and, I would speculate, will do something to curb these practices if not outright bar them," he said. The SEC is reviewing comments from the public on a "concept release" it issued in February. But with an ambitious stock market reform package before it now, the SEC is likely still months away from tackling the options market issue. "Public comments are currently under staff review," said SEC spokesman John Nester. SEC staff is studying three possible strategies: forcibly narrowing spreads; urging greater use of quality data in routing orders; or simply restricting the order payment programs that are now widespread, said sources familiar with the matter. Each potential fix comes with a tangle of complications and market participants are unsure if the SEC will take action. 'SEC AT CROSSROADS' ON OPTIONS "The SEC is at a crossroads. They either have to take a dictatorial approach ... or a laissez-faire approach where the inefficient markets will correct themselves," said Herb Kurlan, head of options firm MDNH Partners in San Francisco. In a perfect world, orders for options -- contracts for the right to buy or sell underlying assets at a preset price within a set period of time -- would be open for competition from all market players and then flow automatically to the best price. In the real world, options orders sometimes flow that way, but often don't, due to internalization or payment for order flow. That's partly because of the struggle for business that has developed since pro-competition reforms in 1999 among the different options exchanges, now numbering six. "Another reason is that order flow providers have now taken the stance that they want to provide the markets and internalize the order flow themselves," Kurlan said. One reform under SEC consideration is to reduce the options market's present trading increments of five cents or 10 cents, depending on the contract price, to one cent. Penny-increment trading was introduced in the stock markets over three years ago. It has contributed to a decrease in the use of payment for order flow in stock markets, the SEC said. But options markets generate so much data that penny price points would present a crushing capacity problem for electronic systems, said Christopher Nagy, director of trade at Ameritrade (AMTD.O: Quote, Profile, Research) , one of the biggest electronic order flow providers. The SEC is also looking at requiring options markets to compile and routinely publish data on how efficiently customer orders get executed at different locations. Order execution quality data is now available in equity markets. Combined with other possible changes, disseminating this data could help drive orders toward the most efficient market makers, sources close to the commission said. Finally, the SEC is evaluating possible outright bans on payment for order flow, internalization and related dealings. "The SEC is making this issue far more complicated than it needs to make it," Parker said. Since payment for order flow and internalization "cannot benefit the investing public ... they should be barred. Period."