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June 30, 2001

Knight's Regional Exchange Feud: The regional exchanges are about to be given a big regulatory adva

By Gregory Bresiger

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  • Knight's Regional Exchange Feud: The regional exchanges are about to be given a big regulatory adva
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Knight Securities, the biggest market maker in Nasdaq securities, and several big regional exchanges backed by the NASD, are at war.

The casus belli is a dispute over several rules extensions before the Securities and Exchange Commission, extensions that would provide more competition in Nasdaq trade executions for the independent marker maker. But several attorneys believe that Knight is a modern day King Canute, unsuccessfully trying to hold back the waves of competition.

Over the past few months, several regional exchanges, with the backing of the National Association of Securities Dealers, have asked the SEC to approve increased Nasdaq trading. This would be accomplished by expanding the coverage of the joint transaction reporting plan for Nasdaq securities traded on an exchange on a listed or unlisted basis (via the UTP, or Unlisted Trading Privileges Plan).

Although few prominent market makers have seemed to join Knight's crusade - at least publicly - to stop the regional expansion into its territory, Knight's top lawyer said the issue is one of critical industry-wide importance.

Order Flow

The proliferation of Nasdaq trading at regional exchanges would likely cut into the order flow of market makers, allowing more exchanges to become big players in Nasdaq. That could hurt the operations of the Knight Trading Group, parent of Knight Securities in Jersey City, which is heavily dependent on its Nasdaq business. Knight officials said this rule extension is an industry issue of great import not only to itself, but for all market makers.

"This is more important than Reg. ATS and not quite as important as the order handling rules," according to Michael Dorsey, general counsel at Knight Trading Group.

Knight insists that these rules extensions would be "inappropriate." They would allow regionals - through a regulatory coup de main - to have a much stronger presence in Nasdaq trading by using their unlisted trading privileges, according to critics. And potentially, critics add, they would allow exchanges and electronic communications networks to use the coming Nasdaq SuperMontage to obtain access to the order flow that has helped Knight become a powerful market maker.

On the other hand, supporters of the UTP rule extension say that Knight is fighting progress. In the future, there will be more competition in Nasdaq securities. The SEC has encouraged more competition, taking what many view as pro-investor steps with its approval of Nasdaq's SuperMontage while collapsing Nasdaq spreads through rule changes.

Some brokers, according to one expert, want more competition too, because they are worried about Nasdaq dealers trading against order flow and may find regional exchanges to be more respectable. If granted the extensions, UTP privileges would expand the number of Nasdaq securities that can be listed on several regional exchanges.

Securities attorneys are burning up many billable hours debating these issues. That's because these rules changes, critics charge, would effectively allow regionals to avoid all the requirements that apply to broker dealers and undermine the listing requirements of the Securities Act. And how would this end run around the rules be accomplished?

"Currently, the members of the regional exchanges are not required to comply with Nasdaq rules and interpretations because they are not members of NASD," officials of Knight wrote in a recent filing with the SEC.