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June 30, 2004

Saving the OTC Market

By John A. Byrne Editor

Who says the days of the traditional U.S. OTC market maker are numbered? At least 77 percent of respondents in a recent electronic poll, conducted by Traders Magazine, think so. Admittedly, this result could include the votes of some trigger-happy professionals who have no regard for conventional dealers. But judging by the growth in electronic trading - from ECNs and ATSs to algorithms and programs - it is beyond a shadow of a doubt that the old market making model is going through some changes. That's why it might surprise some that a new group is defying conventional wisdom. It is attempting to bring back what it considers a pure OTC market - with dozens of U.S. dealer firms risking capital - in support of thousands of small and emerging companies. It believes Nasdaq has abandoned the traditional market maker system. At the start, some industry pros were skeptical of the campaign by the United States Capital Markets (USCM), a mouthful that suggests a grand and regal design. However, in the past few weeks, this campaign has gathered a head of steam. The USCM, headed by Arthur Pacheco and K. Richard Niehoff, has so far tried, unsuccessfully, to purchase the OTC Bulletin Board. But now it is pressing its case with the NASD, which could help facilitate a sale to the USCM. If it acquires the Bulletin Board, the USCM has big plans to change the technology. Failing all of this, sources say the USCM will try to launch its own dealer market.

On both counts, the group has been encouraged to move forward. The Securities and Exchange Commission has had cordial meetings with the USCM. There is also financial support from various trading participants in the U.S. and overseas, including the Toronto Stock Exchange and the Shanghai United Assets and Equities Exchange. The latter two are contributing hard cash and are interested in cross-listings. The SEC will likely lean in the direction eventually pursued by the NASD. But, most important, what are the USCM's chances of success? Will the USCM's plans end up in the trash heap of history? Will the USCM's efforts be eventually viewed as the last desperate attempts at restoring the faded glory of a bygone era? The chances of success actually look strong. Sure, the sort of trading envisaged by this group must not be confused with the large-cap stock trading of the listed markets and Nasdaq's top-tier issues. The USCM's market is a special niche, which some feel has gotten short shrift with the current algorithmic and computerized craze. The truth, of course, that the small-cap market has had its share of disasters and questionable players. Still, the USCM is headed by respected leaders, including the OTC activist Pacheco and Niehoff, the former president and CEO of the Cincinnati Stock Exchange (now the National Stock Exchange). The best part is, despite what the naysayers say, OTC dealer intermediaries will be vital once this uncertain up and down stock market retreats back into its cave.

John A. Byrne