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June 30, 1998

The Fight Over ECN Fees

By Howard L. Haykin

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  • The Fight Over ECN Fees
  • Page 2

A full-blown dispute has emerged between traders and electronic communications networks (ECNs). At issue is the transaction or access fee, charged each time a market maker hits the bid or takes the offer on a stock an ECN is publicly quoting on Nasdaq.

Many market makers complain that these fees should not be charged, in part because ECN orders are similar in one respect to the quotes posted on Nasdaq by market makers. They are all part of the Nasdaq price-quote montage.

Consequently, many market makers, from the largest to the smallest, are refusing to pay access fees on orders executed as a result of ECN price quotes on Nasdaq. ECNs, in turn, are now refusing to accept orders preferenced by some of the brokers withholding access payments.

Compete Publicly

Market maker quotes and ECN customer orders compete publicly each day on Nasdaq. Some of the best known ECNs are Reuters Holding's Instinet and Bloomberg Tradebook. ECNs frequently stand alone at the inside price. In some securities, in fact, ECN orders outnumber market-maker quotes. That is likely to become more common as firms reduce their market-making commitments and new ECNs enter the market.

In addition to the access fees charged at up to one and a half cents per share as well as the ECN's posted stock prices, traders incur Nasdaq's one-cent fee whenever their trades with ECNs are transmitted over SelectNet. ECN customers on the other side of the trade are often charged a similar ECN fee, but are not charged a Nasdaq fee.

Market makers, on the other hand, do not charge an access fee. Nor do they pass along the ECN fees, which can add up quickly, to their customers. As market makers see it, the ECNs should be collecting fees only from their customers, who are getting the benefit of executions on their anonymous orders. Without regulatory guidelines, many market makers, as mentioned earlier, are withholding payments to ECNs. These tactics have resulted in several legal and regulatory issues noted herewith:

*Breach of agreement lawsuits.

ECNs are allowed by the Securities and Exchange Commission to charge a reasonable fee to non-subscribers for accessing an ECN. An ECN, which is responsible for communicating its fee structure, may require that non-customers enter contractual agreements on the payment of access fees. Furthermore, the SEC has informally told ECNs that they may refuse to trade with any entity that does not pay its fees.

The first of probably many lawsuits was recently filed by Montvale, N.J.-based All-Tech Investment Group, operator of the ECN ATTN, against a large Jersey City-based Nasdaq wholesaler.

*Heightened NASD scrutiny for unnecessarily locking or crossing markets.

A locked or crossed market occurs when the publicly-displayed inside bid and offer prices are identical or inverted (e.g., an inside bid priced at 10 1/2, and an inside offer priced at 10 1/2 or 10 3/8). A market maker is more likely to enter a locking or crossing quote when it is denied access to an ECN's inside market in order to attract trading interest. While failure to pay an ECN its fees may not be a regulatory issue, the increased incidence of locked or crossed markets is a market-integrity issue.

*Best-execution violations.

This could occur if traders are unable to obtain the best Nasdaq price available.