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February 2, 2006

SIA Criticizes SEC Over Liquidnet Exemption

By Gregory Bresiger

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  • SIA Criticizes SEC Over Liquidnet Exemption

The Securities Industry Association (SIA) is challenging the Securities and Exchange Commission for granting Liquidnet an exemption from the new fair access threshold. It was lowered from 20 percent to 5 percent under Reg NMS.

The SIA's Trading Issues Committee told regulators it has "serious concerns" about the exemption.

"The concern is exacerbated by the fact that other similar ATSs will take advantage of the exemption, thus driving more liquidity displayed among their own subscribers on such systems beyond the fair access provisions," wrote Mark Madoff, chairman of the SIA Trading Committee. Madoff wrote the exemption undermines the goals of Reg NMS and Reg ATS-fair trading for public investors.

The rule now forces an ATS, that has at least 5 percent of the trading volume in a security, must have written standards for granting access to its trading system. The ATS also "must not unreasonably prohibit or limit any person in respect to access to services offered by such system by applying these written standards in an unfair or discriminatory manner," according to Reg ATS.

The controversial exemption benefits Liquidnet and potentially other alternative trading systems. These are systems that may or may not display orders to system subscribers, but never to the broader market. The regulator, in explaining its decision, said: "An unintended consequence of lowering the fair access threshold rule," the SEC wrote, "is that an ATS such as Liquidnet-whose business model depends on preserving subscribers' confidence that information about their trading interest will not leak outside the system-could lose the ability to deny access to those who would leak such information. The Commission recognizes the difficulty of crafting an access standard that would be unfair or discriminatory in view of Liquidnet's need to judge the likelihood of a participant's engaging in objectionable behavior," according to the SEC order.

But Security Industry Association officials, in the letter to the SEC, contend that this exemption for these kinds of ATSs has "no reasonable basis."

Critics of the controversial ATS exemption believe that Liquidnet, if this exemption holds, will in effect be allowed to become an unregistered exchange. That is a privilege that others in the industry might also seek, the critics say.

Seth Merrin, CEO of Liquidnet, said that he was "perplexed" by the SIA letter. He said that some of those objecting to the exemption "just don't understand what we do."

Merrin emphasized that Liquidnet is a select' brokerage firm and that rivals are upset about its efficient ways of accessing liquidity. If Liquidnet, he asserted, was using human intermediaries and was not totally electronic, no one would be objecting to exemptions.

Still, an official of another ATS disagreed. Fred Federspiel, chairman of Pipeline Trading Systems, said Liquidnet has been testing the limits of how to get around the fair access rules.

But Merrin added that, "The SEC is not in the business of creating impediments to new effective ways of trading." Nevertheless, Madoff, in an interview with Traders Magazine, complained that, "[Liquidnet] actually is the one putting up impediments to my participating in his system. We're the ones who are excluded."