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November 1, 2000

Making Nasdaq Fair Making Nasdaq Fair

By Douglas Atkin

Information technology is promoting greater market efficiency and activity, but also a rise in trading profits.

This may run counter to intuition, but it is nevertheless true. Based on the facts, we should be embracing market efficiency with open arms.

According to Salomon Smith Barney, Nasdaq OTC trading profits have risen steadily from $1.3 billion in 1990 to $5.5 billion in 1999. That's better than in other areas of the financial services sector.

Driving these profits, of course, is growth in market assets, but equally important are the changes in market structure in the last 25 years.

Nasdaq's Supermontage

Not everything that has happened has benefited fairness, openness, and competition. Nasdaq's Supermontage proposal, for example, after eight amendments, still fails to create an equitable platform. Instead it creates a system that will cost investors billions each year.

Nasdaq remains the only major market in the world that encourages market maker orders to jump ahead of investor orders.

We believe that investors' orders should remain at the front of the line. Market maker orders and investors' orders should be treated equally and fairly with best execution being the goal.

Instinet's position is that Nasdaq should adopt a single price/time priority algorithm on Nasdaq that is neutral on access fees. With such an algorithm, preferencing on Nasdaq is unnecessary.

Market participants would be free to engage in electronic "upstairs" trading through private networks, but price/time priority would apply on the Nasdaq market itself. Fundamental revisions are required to ensure a level playing field for all market participants.

Enough changes, however, have contributed significant growth. Those changes, which have increased transparency and lowered trading costs, have fueled that growth. And it's not only in the U.S. market, but also in others around the world.

Market reforms lead to greater capital efficiency as well as greater operating efficiency. They lower the costs associated with going into and out of positions. Supporting market efficiencies puts you on the same side as both issuers and investors.

Global Competition

Three global trading regions - the Americas, Europe and Asia - are increasingly moving into competition with each other as places to raise capital.

In our hyper-competitive world, small advantages become bigger, so it will become increasingly difficult to raise capital in an inefficient market when there are more efficient alternatives. You can be sure that there will be alternatives. Germany had two new issues in 1992 and over 250 in 1999.

In order to stay competitive, Nasdaq needs a fundamental change. It should be a market that fosters competition, not monopoly, especially a monopoly operated by the market's regulator.

A government-run monopoly is a deal with the devil. And if you are lucky enough not to pay now, you will certainly pay later.

Government-run monopolies produce Amtrak, while true competition produces a Home Depot, a Cisco Systems and the efficient competing investment banks of the world.

The key to everyone's ability to innovate is competition. Right now, it is impossible to compete with Nasdaq because everyone is required to use its infrastructure, be subject to Nasdaq's rules, and is forced to price against an entity subsidized by a huge market data monopoly. Nasdaq is immune from conventional commercial liability, such as paying for its mistakes.

Ton of Money

Voting for efficiencies has economics on its side. Some brokers are likely to make a ton of money betting on the future model rather than the past.

This will occur because so many of their compatriots will bet the other way, as people often do in times of change. Those who move decisively get first mover advantage' and a disproportionate share of the profits.

What's happening today is not that much different from what occurred in other times, in other industries, and in market after market around the world. Resistance hardly ever made any difference, except to give newcomers time to get established.

That's exactly the opposite of what was hoped for by the champions of the status quo.

I think there is a very strong case to be made that moving toward fundamental change in fairness and competition will be a win-win for both investors and intermediaries.

Douglas Atkin is president and chief executive officer of Instinet Corporation.