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February 2, 2006

NYSE: Nasdaq's Exchange Plan Is Unfair

By Gregory Bresiger

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  • NYSE: Nasdaq's Exchange Plan Is Unfair

The New York Stock Exchange and merger partner Archipelago Holdings blasted a key aspect of Nasdaq's amended exchange application. Their opposition came as dozens of lawmakers urged the regulators to approve the application. (See following item).

However, the criticism could delay or even derail Nasdaq's dream of becoming a stock exchange. At presstime, final approval was pending before the SEC, which had received dozens of comment letters.

The NYSE, in its comment letter, said it supported Nasdaq's bid to become an exchange, but objected to the proposed treatment of trades executed within the systems of current Nasdaq members.

"NASD seeks to subsidize the Nasdaq exchange alone by enabling it to use the revenue from off-exchange trades to defray [Nasdaq's] business and exchange surveillance expenses-thereby discriminating against the other exchanges," NYSE wrote.

The criticism came as Peter Uhlmann, senior adviser to the chairman of the SEC, met with representatives of the New York Stock Exchange to discuss the views expressed in NYSE's comment letters. Attending the meeting were NYSE executives Linda Rich and Robert McSweeney.

Nasdaq, in its latest application, promises to limit the scope of the new exchange, "to those transactions that occur in the Nasdaq Market Center, formerly known as SuperMontage, and Brut." (See Traders Magazine November 2005). These transactions would be done in price/time priority under the plan. But orders filled within the internal systems of NASD members that may not have time priority would be reported through a new proposed trade reporting facility set up with the NASD or through the NASD's ADF.

This set-up, Nasdaq believes, would satisfy the SEC, which has never approved a stock exchange that does not respect both price and time priority.

The Big Board and Arca object on two counts: a market data revenue rebate scheme between the NASD and Nasdaq and the treatment of credit for the internalized trades.

"The proposals create a market structure that enables an exchange to benefit from a print facility that encourages internalization," wrote Kevin O'Hara, general counsel for Archipelago Holdings. "We believe that the proposals are in conflict with what constitutes an exchange and undermine the value that an exchange provides in bringing together orders for interaction and execution."

O'Hara contended that the plan creates a Nasdaq/NASD "shell company that merely serves to allow Nasdaq as an exchange to continue to benefit from a print facility business." Internalization, he argued, would promote the isolation of limit orders.

"For example," O'Hara wrote, "a customer may enter a limit order that improves the current quote. Dealers that match displayed prices rather than executing against displayed orders may leave the displayed order unexecuted." That could led to unexecuted limit orders, he added, because customers will be discouraged from finding better prices. O'Hara contended that internalization has a deleterious effect on investors-it hurts transparency and price competition while increasing trading costs.

Under the latest Nasdaq exchange proposal, the NASD would establish a new trade reporting facility (TRF) for its members' internalized trades. All tape revenues paid by the brokers to the NASD would be transferred to Nasdaq rather than used by the NASD to defray its own costs.