Feb. 20 (Bloomberg) -- The Securities and Exchange Commission staff, over objections of the New York Stock Exchange, is recommending relaxing a rule that requires stock trades to go to the market with the best price, people familiar with the matter said.

The staff's recommendation to ease the ``trade-through'' rule would enable investors to choose speed of execution over best price, which the NYSE provides more than 90 percent of the time. It would also permit trades within a few pennies of the best price in some cases, one person said.

The proposals, scheduled to go to the SEC's five commissioners next week, mark the first clash between the agency and John Thain, who took over as NYSE chief executive last month. Thain, former Goldman Sachs Group Inc. president, told a congressional hearing today the new rule changes could cost investors as much as $3.5 billion a year.

The changes ``would be tantamount to giving financial intermediaries an SEC-approved waiver on one, two, or three cents per share from their fiduciary responsibility to obtain the best price for investors,'' Thain said.

The Nasdaq Stock Market, Instinet Group Inc. and other NYSE competitors say the trade-through rule perpetuates the Big Board's dominance. The exchange has an 80 percent share of the market in trades of NYSE-listed stocks.

Overhaul

The SEC staff recommendations are among a batch of proposed changes that the Washington-based agency is considering to the rules that govern the national securities markets. Those rules were last overhauled in 1975.

The trade-through rule applies to stocks listed on the NYSE and the American Stock Exchange. The rule often channels orders placed on other markets to the Big Board, where human traders, called specialists, match buyers and sellers more slowly than the newer automated systems can.

The five biggest specialists this week agreed to pay about $240 million settle allegations they traded ahead of customers, ending a yearlong probe. LaBranche Co., the biggest specialist, said it will pay $63.5 million.

Fidelity Investments and other institutional investors have said they would sometimes prefer to sacrifice a few pennies per share in return for faster trades and more certainty of execution on more automated markets.

Representative Richard Baker, chairman of the House Financial Services subcommittee on capital markets, is calling for outright abolition of the trade-through rule. Baker, a Louisiana Republican who called today's hearing in New York, called the rule ``an ossified relic of the time when inter-market competition was lacking, electronic trading was in its infancy, and spreads were much wider.''

Nasdaq's View

The trade-through rule doesn't apply to Nasdaq stocks. Nasdaq issued a statement last week calling for the abolition of the trade-through rule. Christopher Concannon, Nasdaq's head of transaction service said he expects the SEC staff will recommend that the rules apply to Nasdaq stocks.

``Unlike 20 years ago when sophisticated routing and execution technology did not exist, investors today can choose many execution factors including price, certainty of price, liquidity and speed,'' Nasdaq said. ``The trade through rule denies investors that choice.''

The SEC staff's recommendation allows investors to ``opt out'' of the quest for the best price on a trade-by-trade basis, the person said.

The recommendations are still under review and could change before Tuesday when the SEC will meet to consider whether to issue them for public comment, the person said.

`Obligation'

The NYSE board recently approved proposals to increase automated trading and to give listed companies more control over who makes markets in their shares. The changes are meant to address complaints that the Big Board's execution is too slow and that its system favors specialists over investors.

The rule imposes an obligation on the U.S. exchanges to refrain from executing a trade in a NYSE-listed or Amex-listed stock if a better price is available elsewhere.

The NYSE released a study this month saying that a weakened trade-through rule would hurt investors. The study said the second-best bid prices for 93 of its stocks within the S&P 100 Index showed that trading at second-best prices would add an average cost of 4.21 cents-per-share to the transactions.

``We are going to need to study their proposal in detail, because it's extremely complex and the ramifications need to be understood, but the fact they're taking this giant step forward is good news,'' said James Spellman, a spokesman for the Securities Industry Association, which represents brokerage firms.

Other SEC staff recommendations include banning stock quotes in increments of less than one penny and possibly capping fees that markets charge for access to the quotes on their systems, one person familiar with the proposals said. Another recommendation would change how revenue for market data is allocated, the person said.

The SEC staff's proposed ban on subpenny quotes responds to the narrowing spread of quotes since the U.S. markets moved from fractions to decimals. Some traders say the subpenny increments are hurting their profit margins.

To contact the reporter on this story: Judy Mathewson in Washington at jmathewson@bloomberg.net

Last Updated: February 20, 2004 12:20 EST