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April 30, 2002

Nasdaq Pricing Discrimination? Critics Go to War Over Proposed New Fee Structure

By Gregory Bresiger

The third phase of Nasdaq's proposed new fee structure violates the objectives of the national market system and raises monopoly issues, according to several critics.

In separate letters to the Securities and Exchange Commission, Instinet and BRUT contend that Nasdaq is trying to hurt those customers who will only be partial users of the Nasdaq facilities such as SuperSoes, a centerpiece of the SuperMontage.

"Instinet believes that the fee proposal seeks to solidify the dominant position of Nasdaq's future for-profit market center by penalizing NASD members for use of competing facilities, in direct contravention of the requirements of the Securities Exchange Act of 1934," Douglas M. Atkin, who recently resigned as president of Instinet, wrote in an April 1 letter. The first two phases of the fee schedule were approved by regulators last year.

"Nasdaq," said BRUT General Counsel William O'Brien, "is fully entitled to be a for-profit entity. But they are using their regulatory history to ensure that they will have unfair market advantages." He wrote that, "Nasdaq is advancing this proposal at a time when no competitive alternative exists with respect to the relevant services being re-priced, namely quotation display and market-maker quotation access."

Advantages Granted

Bill Singer, a veteran New York securities attorney, said the Nasdaq pricing schedule is an "example of predatory pricing." He added that Nasdaq is "becoming a political entity that is trying to help itself."

Nasdaq officials declined to respond. However, they are expected to file a response to the comment letters.

Singer said although Nasdaq is having problems with ECNs, it will later have the same problems with market makers. "Market makers will see that Nasdaq is taking advantage of its regulatory powers," he predicted

In a separate filing, the Philadelphia Stock Exchange also objected to the Nasdaq fee schedule. "In short, the fee proposal is designed more to penalize members for trading Nasdaq securities on other markets than to reward them for using the Nasdaq system," according to Philly's filing.

Both BRUT and Instinet also argued that the rates are unfair because they hurt market players who don't fully participate in the Nasdaq's SuperMontage project and who might direct part of their business to the competing ADF (Alternative Display Facility). BRUT notes that partial users will pay a nickel more in execution costs for SuperSoes executions per 100 shares. Quotation update charges will also be a penny more for partial users.

However, Atkin's letter continues, "because of Nasdaq's overwhelming regulatory, infrastructure and liquidity advantages built up as an arm of the NASD, ECNs and ATSs will remain captive to Nasdaq's systems for a significant fraction of transactions." Those who will make all their trades with Nasdaq will be rewarded with lower fees, critics charge.

Atkin and BRUT contend these fee proposals are designed to increase their costs, rendering them less effective competitors of Nasdaq.

"Nasdaq does not link lower prices to any efficiency that may be achieved through lower volumes - the incentive provided is solely to choke off Nasdaq's competitors," Atkin wrote. Instinet provided a schedule of trading costs for four firms. One firm reports 100 percent of its trades through Nasdaq, using no alternative channels. It pays $450 in fees, with a penny charged per each update.

Another firm, which goes outside for 20 percent of its trades and uses Nasdaq for 80 percent of its business, pays $15,000 in fees. A third firm uses Nasdaq for 90 percent of its trades and will pay $12,000 in fees under the new schedule. The latter two are paying two cents per each update.

Atkin concludes: Alternative trade reporting venues will face rough going holding onto these latter two firms. Nasdaq is penalizing those who won't give it all its business, he charges.

"It [Nasdaq] claims that it is justified in imposing higher costs on firms that do not direct all their business to Nasaq because such firms contribute less to financing Nasdaq's overall operations," Atkin wrote.