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July 31, 2002

Trade Rebates Hang in the Balance

By Gregory Bresiger

Trading rebates practices will still be allowed in a modified form, but for how long?

That's what officials of various regional exchanges are trying to figure out.

The trading industry is trying to figure out the effect of the Securities and Exchange Commission's recent actions reducing rebate programs.

As Traders Magazine went to press, regulators said that stock exchanges will still be allowed to rebate some of their revenues. For example, exchanges will be permitted to refund up to 50 percent of revenues on American Stock Exchange securities.

Proposals on Hold

However, the regulators are still taking a close look at what will happen to rebate revenue on controversial Nasdaq issues. Recently SEC officials suspended all Nasdaq rebates, but asked exchanges to submit proposals to permit some form of the practice. But now the regulators have told exchanges to put the proposals on hold.

At the time of the suspension, SEC officials wrote that, "The commission believes that such trades may be distorting the actual volume of trading in these securities." Market data rebates, regulators said, could distort the trade reporting process and hurt funding for regulatory oversight. The action came just after the National Association of Securities Dealers had charged that Swift Trade Securities had engaged in phoney trades. The NASD said that the Toronto brokerage had executed fraudulent trades in the Nasdaq-100 Index Tracking Stock, which is also known as the QQQ. Swift had turned a $19,000 profit in market data revenue trading through an ECN, according to regulators.

The actions of the regulators - squeezing the economics of exchange rebate programs - has left many exchange officials stunned and confused. How can they submit a plan for acceptable rebates in Nasdaq securities?

The regulators contend that, for now, it is tempting for dishonest officials to register false trades because it only costs a few cents for a market maker to register a trade with an exchange.

An SEC official, in a recent published report, said, "We are reviewing all trades, including Nasdaq trades. There has been suspicion of wash trades in areas other than just tape B trades."

Another issue for the SEC is the potential for foul play with tape revenues. By giving it away, an exchange would have less money to spend on regulation.

This has been a criticism of Nasdaq officials, who have questioned the ability of regional exchanges, such as the Pacific and the Cincinnati, to print their own trades.

But regionals say they are ready to ensure that rebated trades - a profitable practice for them - are executed in a legal environment. The Cincinnati Stock Exchange last year decided that it would share 75 percent of its tape revenues with market makers that use it for Nasdaq trade reporting. Island ECN, a large center of liquidity, took up the offer and started sending trades through the Cincinnati this past February. But now Cincinnati officials, who have had public battles with Nasdaq, say they're confused by the regulators actions.

"We are weighing up all our options in the new environment," according to David Colker, who is chief executive of the Cincinnati.