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June 6, 2006

ECNs Packing Their Bags: Saying Sayonara to Nasdaq

By Peter Chapman

Some or all of the five independent ECNs will likely leave Nasdaq for the NASD's Alternative Display Facility or a regional stock exchange.

The ECNs-BATS, DirectEdge, Track, OnTrade, and Bloomberg Tradebook-are said to be in talks with the NASD and the regional stock exchanges to display their quotes on their systems.

The talks come as Nasdaq is taking steps, the ECNs say, to make it impossible for them to conduct business as a part of Nasdaq.

"The ECNs have gotten the message that they are no longer welcome," said Dave Cummings, chief executive of BATS. "They will quickly find alternatives, whether it is the ADF or one of the regionals.

The ECNs charge Nasdaq is trying to kill their businesses with two tactics. First, Nasdaq wants to levy a new fee on the ECNs. Second, it will force them to accept automatic executions against their quotes.

Nasdaq originally wanted to levy the new fee April 1. That led to the ECNs complaining to the Securities and Exchange Commission. Four of the ECNs-all accept for Citigroup/OnTrade-sent the SEC a letter.

"Nasdaq's proposed changes would put the independent ECNs out of business," the heads of the four ECNs told the SEC's acting director of market regulation, Bob Colby, in the letter. "It would make them unable to compete effectively as liquidity providers."

The ECNs told the SEC that the proposed changes were discriminatory and anti-competitive. They asked the SEC to require Nasdaq to open up the fee proposal to public comment.

Co-signers to the letter include Kim Bang, chief executive of Bloomberg Tradebook; Cummings, Ronald Pasternak, president of DirectEdge (owned by Knight Capital Group); and Marty Kaye, chief executive of Track ECN.

The letter was effective. Nasdaq backed off. The fee proposal, Nasdaq confirms, will be put out for comment. Cummings maintains the ECNs won a delay, but no more. "This gives us enough time to get off. You'll see us developing alternatives by the end of [April]," the exec told Traders Magazine. Nasdaq, the ECNs say, has proposed two changes in the way it accommodates ECNs on its systems. First, it wants to shift the burden of an order delivery fee from the brokerage house sending the order to the ECN receiving it.

Today, Nasdaq charges firms $0.001 per share to use its systems to route to an ECN an order that removes liquidity resident on that ECN. Effective, April 1, Nasdaq will stop charging the order sender and levy the $0.001 fee on the ECN.

That change, the ECNs say, will make their pricing models uncompetitive. Now, they may charge liquidity takers up to $0.003 per share and rebate liquidity providers $0.002, giving them a spread of $0.001. Nasdaq's proposal could eliminate that spread.

Nasdaq maintains the switch is fair. "We believe the firm that receives the volume and the order delivery benefit should pay," says a Nasdaq spokesperson.

In another controversial move, Nasdaq is proposing to eliminate the method by which ECNs receive orders, according to the ECNs. The stock exchange would replace it with a method that would subject them to extraordinary risk, the ECNs claim.

ECNs now accept orders via an "order delivery" mechanism. The method gives an ECN time to determine the availability of a contra-side order residing on their books.

The method eliminates the risk of a double execution that could occur if the contra-side order had already traded. That might occur if orders reach the ECN via systems other than Nasdaq's.

Under Nasdaq's proposal, ECNs would be forced to accept automatic executions against an order residing on their books. That would expose them to the risk of two executions, the ECNs complain.

Nasdaq denies it intends to force ECNs to accept automatic executions, but Cummings claims it is a "certainty." Nasdaq is consolidating its trading on its recently acquired INET platform. That platform does not offer order delivery, Cummings says. "They are moving to the INET platform," Cummings adds, "and it will not include order delivery or ECNs."