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May 31, 2003

SEC Economist Pushes Scheme for Rebates

By John A. Byrne

Larry Harris, the SEC's chief economist,says he's ready to help solve the controversy on market data rebates.

But the adoption of his far-reaching proposal will rest on the political support he can muster among SEC colleagues, Harris told Traders Magazine.

Harris, speaking at a conference on institutional trading at Baruch College in New York, said rebates should be allocated to self-regulatory organizations based on time, size and on the orders that improve on the NBBO.

The current rebate schedule, which is based on the number of transactions, leads to problems, said Harris. Some participants abused rebate programs to generate more revenues. In one example, NASD Regulation prosecuted and fined Swift Securities in Toronto for inflating transaction volume in Amex-listed QQQs on Island.

His alternative plan, Harris says, would foster more competition and diminish phantom transactions. The rebates programs on Nasdaq trading reached a climax last year. That's when the Cincinnati Exchange rebated 75 percent of market data revenue on Nasdaq Level I and II stocks to participants printing Nasdaq trades on the exchange. The plan was supported by Island ECN, which printed trades on Cincinnati. And it forced Nasdaq to launch its own rebate program - a rebate of 80 percent on Level 1 trades. However, the Securities and Exchange Commission later abrogated rules filed by Cincinnati and the National Association of Securities Dealers. That step had the effect of halting the Nasdaq rebate programs.

Harris, an expert on market microstructure who is on assignment at the SEC from the Marshal School of Business, thinks he has a good shot at convincing others at the SEC of the merits of his proposal. But it is still in the early stages of discussion.

Nonetheless, it got a mixed reaction from one former SEC economist. He is Gene Finn, who has previously advocated rebating market data revenue directly to dealers. Finn recently wrote to the SEC criticizing the current regulatory approach on market data rebates.

Under Finn's plan, fees would be rebated to dealers that are at the inside price. But Finn dismisses charges that participants that break up trades damage the market. Trades are constantly broken up into smaller transactions, he noted. There is nothing wrong with that much of the time, he said. "The SROs don't like it because it hurts their revenues, " Finn told Traders Magazine. Harris, for his part, said his proposal would encourage innovation and reward liquidity if it were adopted.