On Monday, March 5, 2007, exchanges and electronic communication networks (ECNs) will begin complying with the Trading Phase of Regulation NMS. The Trading Phase was designed to identify and work out any problems before full effectiveness of Regulation NMS. Beginning March 5, 2007, the exchanges and ECNs participating in the Alternative Display Facility of the NASD will implement policies and procedures reasonably designed to prevent trade-throughs of better-priced protected quotations displayed by other exchanges and ADF participants. On July 9, 2007, securities firms also will comply with the trade-through provisions of Regulation NMS for 250 pilot stocks.
In recent months, many of the exchanges and ADF participants have developed new automated trading systems or significantly modified their existing automated trading systems. Many of these systems route orders out to access better-priced protected quotations at other markets. In addition, many securities industry participants may choose during the Trading Phase to begin routing intermarket sweep orders (ISOs). An ISO allows a receiving trading center to execute the order without regard to any better-priced protected quotations at other trading centers. The router of an ISO, however, is required to route additional ISOs, as necessary, to execute against any better-priced protected quotations at other trading centers. The Trading Phase is designed to provide all industry participants with an opportunity to gain experience with the new trading rules, including ISOs, prior to Regulation NMS becoming fully effective.
The start of the Trading Phase is a very important step in the implementation of Regulation NMS. The Commission staff, in consultation with the self-regulatory organizations and other securities industry organizations, has monitored the status of the industry's implementation efforts. The exchanges already have rolled out the most significant aspects of their new trading systems over the preceding weeks and months, but some will rollout new functionalities on March 5th. A market's rollout of new trading systems inevitably presents challenges for the market and its participants. In addition, the exceptional trading volume and price volatility of the equity markets over the last few days raise the potential of even greater challenges during the Trading Phase.
Throughout the Trading Phase, the Commission staff will closely monitor the operation of the equity markets to assess whether any systems or other trading problems arise. Regulation NMS addresses systems problems through an exception for trades executed at a time when a trading center displaying a protected quotation is experiencing a failure, material delay, or malfunction of its systems or equipment. (Rule 611(b)(1), commonly referred to as the "self-help" exception.) The self-help exception also excepts the routing of ISOs. We recognize that use of this exception will be appropriate if systems problems arise at one or more markets.
As a supplement to individual use of the self-help exception during the Trading Phase, if market-wide problems arise, the Commission staff intends to consult with the self-regulatory organizations to assess whether these systems problems are so serious that an industry-wide exception should be triggered under Rule 611(b)(1). Staff particularly will consult on this matter with the NASD, as the primary self-regulatory authority with responsibilities for broker-dealers participating in multiple markets. When appropriate, either the Commission or NASD will issue a public notice that the equity markets are experiencing conditions that appropriately trigger an industry-wide use of the self-help exception. This industry-wide exception would effectively suspend operation of all trade-through provisions. For example, it would allow all trading centers and order routers to execute trades and route ISOs without regard to the protected quotations displayed at any particular time. The exception would continue for the time period specified in the notice.
The U.S. equity markets are the deepest and most liquid in the world and vitally important to the U.S. economy. Should serious systems problems or difficult market conditions arise, I believe that the first priority should be to enable the equity markets to continue trading and establishing the most efficient prices possible for investors.