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August 31, 2001

Pennies Squeeze Wholesale Services

By Peter Chapman

Penny ticks have pushed rebates and liquidity guarantees on Nasdaq trades lower at two of Wall Street's top Nasdaq wholesalers.

As April's cut in the minimum trading increment from six-and-a-quarter cents to a penny has increasesd the risk for dealers, Knight Trading Group and Bernard L. Madoff Investment Securities have reduced the size of their rebates for orders and are executing fewer shares at the inside.

Penny increments, mandated by Nasdaq under decimalization, have led to a reduction in the number of shares quoted at the inside. The lack of depth means market makers must frequently unwind their positions at prices less favorable than when they were created. Consequently, the value of the client orders that create the positions is diminished.

"As depth has dropped to below 300 shares and the effective spread is as little as a penny, an order has a different trading value," explained Knight chief executive Ken Pasternak. Shares at the inside have declined across the industry from an average of 1,100 before April to 300 today, Pasternak noted.

Knight has even gone so far as to eliminate rebates to one group of clients and charge another group - active traders, such as day traders and program traders - a half-penny per share to execute orders.

Still, Knight has no plans to cut rebates to its core client base of online discounters, Pasternak said. "We don't believe their economic profile nor the marketplace is ready for that," he said.

Mark Madoff, a co-director of trading at Madoff, says the family-run firm has no intention of charging any of its customers a fee. Madoff is sticking with the rebate and liquidity guarantee policy it instituted two years ago.