A true national market system would have the following property. There are clearly defined points of entry to the system: that is, when an order is placed on specific exchanges, ECNs or ATSs, they will count as part of the system. These orders are time-stamped by a perfectly synchronized process. In other words, it doesn’t matter where your point of entry is, the time-stamp on your order will put it in the correct order relative to every other part of the system.
Order matching engines are, then, required to take the time to check that time-priority is respected across the national market system as a whole.
This structure would eliminate many of the nefarious aspects of speedy trading, while at the same time allowing high-speed traders to provide liquidity within the constraints of a strictly time priority system. Speedy orders couldn’t step in front of existing orders, because time-priority would be violated. Cancellations couldn’t be executed until after the matching engine had swept the market to look for an order preceding the cancellation that required a fill. In short, speedy traders would be forced to take the actual risk of market making, by always being at risk of having their limit orders matched before they can be cancelled.
Overall, it seems to me that the error the SEC made was in creating a so-called “national market system” without a time-priority rule.
Note: this post was probably influenced by @rajivatbarnard ‘s tweets about this same topic today.
Update: Clark Gaebel explains very clearly that we don’t have anything remotely resembling a “national market system.” We have a plethora of independent trading venues and your trade execution is highly dependent on your routing decisions.