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April 1, 1999

The Piecing Together of a Fragmented ECN Market Will Goal of NASD's Agency-Quote Proposal Be Acco

By by Shailaja Neelakantan& John A. Byrne

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  • The Piecing Together of a Fragmented ECN Market Will Goal of NASD's Agency-Quote Proposal Be Acco
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How many electronic communications networks (ECNs) can the equity markets support? By the sound of some Nasdaq and institutional traders, the answer is very few.

"The Securities and Exchange Commission has spawned a mini-cottage industry," complained Nick Karos, managing director of Nasdaq trading at U.S. Bancorp Piper Jaffray in Minneapolis. "The problems with them can only get worse."

The problems that Karos was referring to are an eclectic mixture of dizzying price-quote traffic, liquidity, anonymity and other concerns on the nine ECNs approved so far by the SEC.

A new twist occured when the National Association of Securities Dealers sent its agency-quote proposal to the SEC for approval. If implemented, the rule would empower market makers to run what, in effect, are their own ECNs.

As currently envisioned, the rule would allow market makers to post customer limit orders anonymously, using an agency acronym separate from the market makers' proprietary quotes.

But such a prospect raises the blood pressure of some traders.

"On an average stressful day, Nasdaq cannot handle traffic," said Arthur Pacheco, president of STRIKE Technologies, operator of a consortium-owned ECN based in New York.

Some trading professionals echoed Pacheco, noting that Nasdaq's computers are so strained that some trade confirmations are not transmitted fast enough. Nasdaq is currently adding more bandwidth to its network.

Although he is hardly an impartial observer, Pachecho noted: "If you add the agency-quotation ability to all the market makers, there is a potential to at least double messaging traffic. And that's only the tip of the iceberg."

"Capacity is definitely an issue," agreed James Marks, electronic commerce analyst at Deutsche Bank Securities in New York.

U.S. Bancorp's Karos added that the agency-quote proposal makes no sense. "We need less pieces of the puzzle. The more there are, the more ways to break," he said.

Still, Karos is more concerned at the moment about what it is costing him to use ECNs.

"Everytime I have to access [an ECN's] quote I have to pay the ECN a fee. Every time an ECN has to access my quote, I can't charge it anything," Karos explained. "What the SEC has created is an unlevel playing field."

Sometimes, market makers are forced to access an ECN when it alone is at the inside market, especially in high-volume technology stocks.

The individual investor ultimately pays for the service because the access fee becomes a cost of conducting business, a cost incorporated by a trading desk in its fee structure, traders say.

"The way it should work is this: If you are a member of an ECN, you alone should pay for the use of the ECN," Karos said.

For its part, the NASD contends that the agency-quote proposal will actually level the playing field for Nasdaq market makers that feel stiffed by ECNs.

"One issue market makers wanted [resolved] was the ability to charge on their agency orders the same way an ECN can do now," said Alfred Berkeley, president of Nasdaq. "The agency quote lets them do that."