The push to link all four U.S. options exchanges has caused a battle among them over how to get the best price for a customer's order.
At issue is price/time priority routing, which gives trading preference to the exchange quoting the lowest price on an option at the time the order is made. It does not allow another exchange to match the price.
The fight pits the Chicago Board Options Exchange, the nation's largest options exchange, and the American Stock Exchange against the smaller Philadelphia Stock Exchange and Pacific Stock Exchange, based in San Francisco.
The Chicago, Philadelphia and Pacific exchanges all submitted plans to the Securities and Exchange Commission on how to link the exchanges on Jan. 19, after the SEC-imposed deadline for an industry solution expired.
The CBOE's plan, also supported by the Amex and International Securities Exchange, an all-electronic options exchange expected to begin operation later this year, argues against price/time priority. The Philadelphia and Pacific exchanges' plans favor it.
In a Dec. 10 letter to SEC Chairman Arthur Levitt, CBOE Chairman and CEO William Brodsky stated that price/time priority "would have the overall effect of reducing competition both between exchanges and within an exchange as it reduces incentives to compete other than on speed of quote change and would punish efficient markets that offer superior services and lower costs in addition to the best price."
In his Jan. 19 proposal to the SEC describing the CBOE's plan, Mr. Brodsky said mandated price/time priority "is a mandatory routing switch that would eliminate competition between markets and undermine broker-dealers' efforts to secure best execution for their customers."
In contrast, Dale Carlson, a spokesman for the Pacific exchange, said, "We have an opportunity here that comes once in a generation and we ought to do it right. We should give an incentive for markets to quote (prices) aggressively.
"We also need to be able to protect public limit orders across markets. Matching (orders) doesn't do that.
"Too often when we discuss changing markets, people behave like Chicken Little. People for the status quo say change will cause problems, but it hasn't happened in the past. Opponents of change cite the same arguments over and over again and have been proved wrong."
He pointed to the battle to eliminate fixed brokerage commissions back in 1975, when one-time Wall Streeters wrongly claimed disaster would strike.
In support of its position, the CBOE has distributed a letter sent to Mr. Brodsky by William C. McGowan, a senior managing director of Mesirow Financial Inc., Chicago, in his capacity as chairman of the Securities Industry Association's options committee. The letter, which opposes price/time priority, represents the views of more than 40 SIA member firms that are active in the options market, Mr. McGowan said.
"Given that factors other than price must be considered by brokers in fulfilling their duty of best execution with regard to customer orders, the linkage system should allow the member firms to have the ability to route orders to a destination of their choice," Mr. McGowan wrote.
The plans submitted in January made "significant progress toward an options market that better serves the interests of investors," Mr. Levitt said in a Jan. 20 news release.
However, he added, "important differences remain. The exchanges disagree on fundamental questions, including whether orders should be routed according to price/time priority and whether customer limit orders should be afforded price protection across markets."
In the next few weeks, the agency will consider the plans, then publish them for comment, he said.
"We will not let the differences among the options exchanges stand in the way of this historic opportunity to achieve a truly national options market," he said.
In an interview, Mr. McGowan added that "Mr. Levitt and the SEC will probably come up with a (linkage) plan if we don't."
The exchanges, he said, "are still talking to each other under the SEC's guidance."