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September 12, 2006

ECN Alliance Formed to Battle Nasdaq

By Gregory Bresiger

A group of four ECNs has formed an association in an effort to convince the Securities and Exchange Commission to reject a move by Nasdaq to introduce changes that they say will cripple their businesses.

The newly formed Association of Independent ECNs wants to stop changes in the Nasdaq trading platform that it says would hurt ECNs, reducing "liquidity and competition."

That's according to Association officials, who have filed recent comment letters and met with the SEC. They have been asking for a six-month grace period to find alternatives to the Nasdaq system.

But Nasdaq officials say the ECNs are trying to penalize them for improving their system. BATS Trading, Track ECN, Direct Edge ECN and Bloomberg Tradebook are the members of the Association. Citigroup Global Markets, owner of the OnTrade ECN, is not.

However, association officials say they are cooperating with Citigroup.

The ECNs have charged that Nasdaq's proposed shift of fees charged away from order entry firms is part of a scheme to put them out of business.

ECN officials contend that Nasdaq supposedly speeded up the recent integration of its trading platforms to hurt them. The integration of the Brut, INET and SuperMontage platforms, which is expected to result in a big cost saving for Nasdaq, was recently approved by the SEC.

"No one wants to be on Nasdaq," David Franasiak, an attorney for the Association, told Traders Magazine.

Still, Nasdaq officials have also said that alternatives are available to the ECNs, including NASD's Alternative Display Facility (ADF). Nasdaq wants ECNs to accept automatic executions against quotes.

ECN officials have said Nasdaq's plan would overtax their systems, resulting in duplicate executions. And, they add, since ECNs are not capitalized for principal trades, duplicate executions could cause economic hardship.

Association officials complain they have few short-term alternatives to Nasdaq, which has said the ECN systems are not fast enough. These ECNs have few short-term alternatives to Nasdaq, according to Association officials. Nasdaq officials have replied that the problem is the ECN systems.

At presstime, BATS was the only Association member to find a new venue. It is using the National Stock Exchange (NSX). However, NSX's capacity isn't large enough for BATS clients. That has led to more locked and crossed markets at the NSX. Some angry clients canceled business.

The controversy, an ECN official asserted in a comment letter to the SEC, has been festering for months as Nasdaq has deceived the regulators about the extent of the problem.

"Nasdaq's communications with Commissioners and staff have been inaccurate or misleading on many significant points," according to Martin Kaye, chief executive officer of Track ECN. Kaye also dismissed the ADF, arguing it is not a reasonable alternative to Nasdaq.

"It is not an execution facility," Kaye wrote. "Market makers and broker-dealers who access Track ECN liquidity through Nasdaq are not connected to the Track system directly and cannot access Track's quotes on the ADF. In addition, the ADF does not provide protection of quotes and currently charges fees that are too high in a low margin marketplace."

Kaye said all the ECNs are affected by Nasdaq's policies.

"This is not simply a dispute between Bloomberg Tradebook and Nasdaq," he wrote. However, Bloomberg has a bigger problem than the smaller ECNs. Bloomberg, with a larger institutional order base than the other association members, has huge liquidity pools and some 10 years of integration on Nasdaq's platform. Bloomberg Tradebook officials have said their system would not be a feasible candidate for a move to the old NSX platform.

Franasiak, noting that BATS lost some business when it departed the Nasdaq platform, said ECNs need more time to ensure a smooth transition.

"This is about getting the cattle from one mountain top to the other without losing the cattle," he said.

Meanwhile, sources said the NSX is close to offering a new trading platform for the ECNs. Nasdaq officials at presstime declined comment, noting they had filed several letters with the SEC.

Still, in these letters, they have said that they went though the proper legal steps for these changes. The comment period, they noted in a letter to the SEC, was over in May.