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Night Owl Update: SEC Offers Suggestions for After-Hours Trading

Caroline Humer

Well, it's a start. The New York Stock Exchange and Nasdaq today released structural recommendations for after-hours trading.

The result? Don't expect retail Microsoft (MSFT) volumes on MarketXT or Island ECN to get into the six-digit range. And don't expect the pros to start trading through dinner either, at least not yet.

But the guidelines call for high advertising standards, investor education about the after-hours sessions and, perhaps most important, a one-hour break between the standard and extended hours. The guidelines were compiled by three of four working groups that have been meeting since early July at the request of the Securities and Exchange Commission.

Pros think the ideas are heading in the right direction.

"Those start to make sense," says Doug Engmann, president of ABN Amro Sage, a clearing firm for market makers. "My biggest concern was that the industry was rushing into doing after-hours when it's not just merely an extension of hours. It affects the entire industry in terms of the credibility of how everybody operates."

Engmann's concerns echo many of those voiced in the securities industry during the past year. When the stock exchanges said they were going to get into the after-hours trading game -- now occupied by electronic trading systems like Island and MarketXT -- the SEC told them to slow down, pending the recommendations.

The working groups on investor protection, clearing and operations issues and trading rules, came up with "recommendations" that begin to chip away at some of those concerns. A fourth report on how the options markets will proceed wasn't released with the other three because it isn't ready yet.

Many of the recommendations of the investor protection committee reflected some of the practices that the early after-hours trading firms have adopted. For example, it recommends that investors be required to opt-in to after-hours trading and be aware of the risks, that limit orders be used instead of market orders and that the industry coordinate education efforts. In addition, advertising standards must be as high as for regular trading sessions.

That's important because after-hours trading has been a marketing push for some brokerages, says Alan Skrainka, the chief market strategist with St. Louis brokerage Edward Jones.

"I think after-hours trading started out as a marketing idea and was being rushed to market so quickly that those of us that are in the industry really wanted people to pause and take a deep breath and really reflect on the implications," Skrainka says.

The report on clearing starts to get down to the kind of detail that Skrainka has been awaiting. Closing prices should be taken at 4 p.m. EDT, when the day session ends, and a second trading session shouldn't start for another hour. Trading before 8 p.m. should always be processed that same day, but after 8 p.m. those trades could be booked as next-day trades if the brokerage can't handle them. Trading itself should be delayed until one quarter after the July 1, 2000 start of decimalized stock prices.

Perhaps the most noteworthy of those recommendations is the hour break. Both Instinet and Island, the two largest after-hours venues, offer continuous trading, and other firms planning after-hours sessions have allowed for only a half-hour break. The Chicago Stock Exchange, for example, has applied for permission to trade from 3:30 p.m. to 5:30 p.m. CT. The SEC is still considering that issue.

Island ECN legal counsel Cameron Smith said any move away from the current hours would be a step backwards for after-hours trading. Smith, who sat on the working group on trading rules, said they had differentiated between primary markets like the NYSE and Nasdaq and ECNs or regional exchanges, saying that the SEC should look at how a one-hour break could apply to the nonprimary markets.

That group recommended that the Nasdaq and NYSE quotation systems be extended beyond current plans for 6:30 p.m. to cover extended trading. (The Nasdaq announced its second delay Friday for extending its SelectNet system to 6:30 p.m., giving a date of Oct. 25. SEC approval is pending.) And the group said the NASD should be able to halt stocks, even if the Nasdaq is closed, as well as consider new rules surrounding pricing of issues.

All that may be well and good, but for Engmann of ABN Amro Sage, after-hours trading remains a minefield.

"It's hard enough during the day," he says. "In the after-hours, you're really gambling when you put an order out there as to whether or not you get a good fill."