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Best Execution Called Ever More Elusive

CHICAGO - Best execution of a trade is increasingly elusive, as options for purchasing securities expand. This was the consensus of executives who addressed the Investment Company Institute's tax and accounting conference here early last week.

The shift to decimalization of price from 1/8's, will mean more competition for orders, as well as heavier volume, executives said. When the stock markets moved from 1/4's to 1/8's pricing, trading volume increased three-fold, they said. A move from prices expressed in 1/8th's to two decimal points will not necessarily mean six times the volume, but it will undoubtedly mean more, they said.

There is no question that when the markets finally move to decimals, competition for orders will heat up, said John Wheeler, manager of equity trading for American Century Investment Management of Kansas City, Mo.

The odd 1/8th's of a cent pricing at the New York Stock Exchange was an old tradition, Wheeler said. The pricing derived from the value of Spanish gold coins, he said.

Electronic communications networks, or ECNs, and passive crossing networks like Intuit, Posit and the Arizona Stock Exchange, are also becoming more popular, executives said. This is true not only because of their average penny-a-share charge, versus the five-cents-a-share charges usually assessed on live floors, executives said.

ECN's and crossing networks provide much-needed anonymity for any investment company with a sizable order or fund, Wheeler said. Anonymity is critical when it is just being established or taking on or selling off a large position, Wheeler said.

"Otherwise, you are giving up a lot of information," Wheeler said. "Never underestimate market impact cost," which can average a minimum of 200 basis points, he said.

Nasdaq prices are also becoming more transparent, due to Nasdaq's efforts to compete with the ECN's as well as the SEC's new order-handling rules, executives said.

Many brokers have also created secondary, "off board" markets where they agree to sell or purchase stocks from fund companies for slim profit margins, usually based on closing prices less 1/8th of a point, Wheeler said. This is also becoming a distinct, new way of obtaining or selling off stock, he said.

After-hours trading is becoming more prevalent, executives said. Firms are beginning to keep late hours to respond to late-breaking news, executives said.

"Some investment firms already have staggered shifts of traders," Burns said. "When will operations be a 24-hour shop? It's already happening at many places," said Thomas DuMais, vice president with The Northern Trust Company of Chicago.

All of these developments mean better price opportunities for fund companies, executives said.

While electronic and automatic systems have captured many trades - 40 percent at American Century - they still do not preclude other, traditional trading routes, Wheeler and other speakers said. Certain broker/dealers or sell-side investment firms may still be a better choice if they can provide access to initial public offerings or other stocks, executives said.

"Full-service brokers can give you better allocation of IPOs and put you first on the call list," said Robert Burns, senior vice president and associate general counsel of MFS Investment Management of Boston.

When the industry moves from settling trades in three days (T+3) to settling in one (T+1) sometime in the next two or three years, best execution will be still harder to achieve, executives said.

"Best execution is a pressing issue with the SEC," Wheeler said. "But it's hard to define. VWAP, or volume-weighted average price: many mutual funds use this."

The SEC has never issued a precise definition of best execution, said Burns of MFS. If it did, it would fine itself unable to adapt as systems and products rapidly change, Burns said.

The SEC's office of inspections does seem to appreciate the nuances of best execution when it visits firms, Burns said.

"The SEC will want to interview your head traders, portfolio managers and compliance officers," Burns said.