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September 30, 2003

Nasdaq Plan for More Order Flow

By Gregory Bresiger

Nasdaq wants to offer bargain basement executions to ECNs with low-fee business models. This is a move that it hopes will turn would be competitors into clients.

In what is likely to be viewed as a controversial proposed rule change, Nasdaq wants to cap ECN fees and give low-fee ECNs the same treatment as market makers. That, Nasdaq officials hope, will increase order flow. But some trading industry officials say it will require ECN customers to make hard decisions.

Nasdaq's proposed rates would result in a dramatic change from today's SuperMontage practices. In the original SuperMontage proposal, Nasdaq was going to give priority to market makers by allowing "fee-free" executions over ECN quotes.

Today, there are three methods of executing - price-time, price-time with ECN fees and price size. The latter favors market makers over ECNs, but that would be ended under the proposed rule, which only contains one model: price-time priority. Nasdaq is also requesting to cap ECN fees at $3 per 1,000 shares, a hefty reduction from the current $9 ceiling.

But ECNs must accept the caps on fees they impose if they want the benefits of the new time priority rules.

"They are asking ECNs either to accept lower fees or leave," said William O'Brien, chief operating officer of SunGard's Brut ECN.

Those not accepting the new rates would start using Nasdaq's SIZE system, which would mean an ECN would lose its independence.

This is obviously a move aimed at higher cost ECNs, with significant sources of fee revenues. For example, O'Brien noted that Brut is using SuperMontage because it is at this time in the best interests of clients. He said that Brut, given its order flow and low rates, would be unaffected by the latest Nasdaq moves. That's because over the summer it cut its take out' rate per one hundred shares to $0.27.

At the time, Brian Hyndman, president of Brut, justified the cut, saying that "today's marketplace is highly competitive with razor-thin margins."

"We're a low cost player," Brut's O'Brien added. "However, Nasdaq still has a decision to make on ECNs. Do they want them as clients or competitors?" he asked.

Another trading industry observer said her reaction was mixed to Nasdaq's proposed changes.

"This will help with some of the smaller ECNs, but I still think Nasdaq needs to take more steps. They need to go all out," said Miranda Mizen, a TowerGroup senior industry analyst. "This will not solve all the problems of the various ECNs that use SuperMontage."