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Although I have gradually moved towards placing the overwhelming majority of my MI trading through "market orders," I still occasionally use limit orders. Any MI investor who has experienced difficulities with limit orders would do well to read the following article from today's NY Times:

Veteran investors know that, in a stock market as jumpy as this one, limit orders are the only way to trade. Setting prices on trades means investors are less likely to overpay to buy or reap too little on a sale.

But limit orders benefit investors only if their brokerage firms actually post the orders for others to see. According to a Securities and Exchange Commission report last week, the prompt display of investor limit orders, as required by securities laws, occurs with a distressing haphazardness.

The report is the result of SEC examinations in 1999 at the nation's stock and options exchanges and at various, unnamed brokerage firms.

Prompt and proper display of customer limit orders is good for investors and bad for dealers, so the reluctance of some firms to abide by the rules is understandable. After all, if a dealer gets a limit order to buy shares at a price slightly below the prevailing market, he can sell shares to the customer at a profit, never allowing another investor, who would be happy to sell his shares for a slightly higher price, to interact with the buyer.

Customer limit orders also narrow the difference between the prices at which a dealer will buy and sell a stock, known as the spread, driving down investor costs. Because this reduces dealers' profits, they have an incentive not to show the order.

The rules surrounding limit orders were enacted in 1996 after the SEC and the Justice Department found extensive investor abuse on the Nasdaq stock market. Four years and more than $1 billion in penalties later, many brokerage firms still seem to view investor fairness rules with contempt.

Investors who place limit orders in Nasdaq stocks appear to fare the worst, according to the SEC. Many Nasdaq dealer firms, for one thing, do not have automated systems to handle their customer limit orders.

And not surprisingly, when orders are handled manually, the SEC examiners found significant problems. At one large Nasdaq dealer firm, a trader working manually failed to display 83 percent of customer limit orders properly.

Problems arose even among firms with automatic order display systems. One firm employee unplugged the automatic system for its entire Nasdaq trading desk for several months without anyone noticing. Other firms failed to display the full extent of customers' orders. At one firm, according to the report, when an order came in from a customer at a better price than the firm's, it simply improved its own quote to match the customer's price. The firm told the SEC that since the customer's order was no longer better than the firm's price, it did not have to display the full order.

Investors who trade on the New York Stock Exchange do not appear to encounter such difficulties. The exchange said that last December, it handled just over 6 million limit orders. Of those, only 21 were displayed improperly.

Most troubling, perhaps, the SEC's report calls into question whether self-regulation in securities markets works. According to the report, some self-regulatory organizations were found to conduct no surveillance of limit order display. One self-regulator examined only a small percentage of executed limit orders, ignoring those that were undisplayed. In addition, some self-regulatory groups failed to refer even egregious rule violations to their enforcement staffs.

Steve Luparello, executive vice president for market regulation at the National Association of Securities Dealers, said that it had brought 49 limit order enforcement cases in the past two years. Since limit orders make up two-thirds of Nasdaq orders, this number may not seem large, he conceded. But the NASD is comfortable with it, he said.

Because the SEC report doesn't name names, it is hard to tell where investors are safe and where they are sorry. But investors who are unhappy with limit order executions should carp loudly to the SEC. The Commission says it is going to step up surveillance of limit order handling. And it needs all the help it can get.
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