To Shred or Not to Shred: Trade Shredding That Is
Effective May 25, 2006, trade shredding is a thing of the past as a result of new Rule 3380, Order Entry and Execution Practices. No, this new Rule doesn't regulate the use of shredding machines. What it does do is prohibit the splitting of any customer order for securities into multiple smaller orders for execution where the primary purpose is to maximize in-kind or monetary payments.
Take the example of a customer who purchases 5,000 shares of G-Corporation. Trade shredding would occur if the broker then split the 5,000 share order into fifty 100-share orders, with her primary objective being to obtain rebates, commissions, or other payments of value. The Rule also prohibits any execution into multiple smaller executions for transaction reporting where the primary objective is to maximize in-kind or monetary payments.
According to the NASD Notice to Members 06-19 (April 2006), Rule 3380 stems from concerns that market participants are increasingly engaging in "trade shredding" as a way to increase their share of market data revenues under joint industry plans ("Plans") which share revenues with market participants who send them orders. This is because allocation formulas for distributing Plan income often greatly emphasize the number of trades (no matter the trade size), creating an incentive for market participants to "trade shred." By prohibiting this potentially distortive practice, the new Rule works to further the NASD's goal of preventing manipulative acts and practices.
Under Rule 3380, which was adopted by the Securities and Exchange Commission on February 24, 2006, "monetary" or "in-kind" payments include (without limitation) "credits, commissions, gratuities, payments for or rebates of fees, or any other payments of value to the member or associated person." The Rule makes clear: come May 26, the days of trade shredding are over.
