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January 1, 1998

Questions About Nasdaq's New Trading-System Proposal:ECNs, Market Makers Concerned About Fairness

By Michael L. O'Reilly

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  • Questions About Nasdaq's New Trading-System Proposal:ECNs, Market Makers Concerned About Fairness

The National Association of Securities Dealers' effort to keep its proposed integrated trading system under wraps, until details were filed for public comment on Dec. 22, riled a well-known electronic communications network (ECN).

"The general NASD membership had not been allowed to hear the proposal ideas beforehand," said Kevin Foley, manager of equity-trading applications at Bloomberg Tradebook, the ECN launched 12 months ago by Bloomberg L.P. Bloomberg is an NASD member firm.

"I am finding out about NASD plans as a member of the general public," Foley added.

The proposed trading platform, originally billed Next Nasdaq, could radically transform Nasdaq's current system. But full details are sketchy, as the trading community has yet to interpret the full scope of the NASD's 119-page filing.

As envisioned by the NASD board of governors, the new system aims to integrate SOES and SelectNet and to provide a voluntary central limit order file.

Some ECNs, meanwhile, worry that the proposed facility could turn into a mandatory, centralizing network that somehow sets the inside market.

Foley worries that the new system could replicate an earlier but unsuccessful Nasdaq plan NAqcess to launch an integrated system.

Foley said that if the market is forced to protect the file and not allow trading around it, the system could unfairly hurt competition.

"It would be unfair if all ECN orders had to go to the book for execution," Foley added. "You can't prevent competition."

However, if the Nasdaq system functions as an ECN, Foley said, it would be a welcome competitor in the marketplace.

Island, an SEC-approved ECN used by day-trading firms, but unpopular with market makers, is also concerned.

"It is hard to say how the new system will look like until it is filed," said Josh Levine, president of New York-based Big J. Securities, prior to the December filing. "If it is fair, that will be great. But if it unfair, it could be awful."

Levine added that an equitable system, in his view, would immediately match customers' orders under certain parameters, and would not shut out rival systems. "Any system just needs to keep a level playing field," he said.

Outlines

Several people close to Nasdaq's Quality of Markets Committee, who were consulted on the NASD's proposed platform, provided some outlines of the system, but were unclear about substantive elements.

Based on accounts from these sources, broker dealers will have access to the system for the execution of customer orders. The current plan allows broker dealers to sponsor an institutional client's direct access to the new system. Under this arrangement, the system would operate on a price-time priority, interacting with any quote in the book.

Nasdaq considered a ten-second delay rule for orders entered into the system, apparently as an effort to curb gaming or market manipulation on ECNs. With the delay rule, an order placed in the new system could not be canceled until ten seconds had elapsed.

SOES Bandits