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April 30, 2002

An OTC Revolution at the Cincinnati?

By Gregory Bresiger

The Cincinnati Stock Exchange (CSE), in a rule change filing, is trying to outdo Nasdaq's attempt to become a for-profit exchange. CSE is requesting the right to trade Nasdaq stocks by using Nasdaq's market structure, a revolutionary change that, if granted, would likely be adopted by many of its other competitors.

"All we're doing is saying that we should have the same competitive structure as the Nasdaq so we can also compete as effectively as Nasdaq," Jeffrey Brown, general counsel for CSE, told Traders Magazine. "We believe this is a very, very important change. Maybe revolutionary."

OTC-UTP System

In its application, CSE, which currently trades Nasdaq stocks, wrote that it wants to take a new approach, introducing the "OTC-UTP System, which makes price/time and agency/principal priorities for bids, offers and orders in Nasdaq voluntary among CSE market participants. The CSE believes that such an open architecture is necessary to attract liquidity from various market participants, including dealers, order-entry firms, ECNs, ATSs and public customers."

"Nasdaq members trade without regard to price and time priority and intend to do so when Nasdaq becomes an exchange," Brown continued in the filing with the regulators. "Nasdaq market makers may execute customer orders without regard to other Nasdaq bids, offers, displayed customer orders, and without being executed through a Nasdaq system. Nasdaq believes that its model promotes competition among various market participants while balancing the fundamental values necessary for the protection of investors."

Brown conceded that the Cincy's proposed rule change will likely not be reviewed before the SEC decides Nasdaq's application to become a for-profit exchange. If CSE's application is approved, it is likely that many other competitors of Nasdaq will also apply for a similar rule change. Nasdaq and the Cincinnati Stock Exchange have battled in the media over the regional exchange's attempt to take business away from Nasdaq.

This, potentially, could dramatically change the competitive landscape as Nasdaq tries to adapt to its new competitive environment.

Nasdaq officials have suggested that the Cincinnati is not equipped to offer the levels of due diligence to ensure quality markets. Indeed, Nasdaq officials are hinting that many of these exchanges that are reducing their ties to Nasdaq are going to run afoul of the regulators.