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February 16, 2009

Hill, Thompson's Nick Ponzio Discusses ...

By Editorial Staff

Nick Ponzio, president and CEO of wholesaler Hill, Thompson, Magid & Co., discusses regulatory proposals and changes in the OTC market regarding order handling.

On FINRA's proposal to remove the three-quote rule for OTC securities

First, what's core and important to our market is investor confidence. During this last year, that confidence has eroded, and that's what concerns me about removing the three-quote rule: It's coming at a time when investor confidence is low, and it is something that offers them protection. It is a protection that has worked because it provides investors with a benchmark.

You have to separate these securities into two areas. First, for foreign securities, there is a reference point-where a stock trades in a country of origin. I would look at that differently than the current proposal, which includes all stocks that have limited quotation. The proposal suggests that the lack of speed and timeliness has had a detrimental effect on best execution. I don't find that to be the case. If you used speed as the only benchmark for best execution for those kinds of stocks, best ex could potentially be harmed. These are sometimes static securities that have less liquidity, so taking the time to check quotes and contemporaneous prints is prudent, and it gives a great benchmark for best execution.

Some argue that requiring three quotes is overly prescriptive. I could easily make a counterargument. Besides the three-quote rule, you might also want to require participants to put up depth of market: Are you good for one share or 5,000 shares? If there's a study that shows taking a little extra time in these less frequently traded securities has been detrimental to best execution, I'd like to see it. I don't see the positive effects in eliminating this rule. An enhancement would be to quote in size, which in my view would add to the integrity of the market.

On the recent introduction of Manning to OTC securities

There have been some good things done with regulation this year regarding real-time reporting, which has been extended to all securities, including foreign securities, as well as the extension of Manning [limit-order] protection. These initiatives have been a positive step, giving more information and greater transparency to investors.

I support the extension of Manning despite the fact that it will have a negative effect on margins for bona fide market makers. But as Cromwell Coulson at Pink OTC Markets points out, I think it will boost investor confidence and increase the integrity of these markets, and I think that should increase [volumes] and offset some of the margins that might be eroding. It is a step in the right direction, and market participants will have to deal with it.

Liquidity providers and bona fide market makers play a very valid and necessary role. It is too early to see how this will play out, but I would like to see the long-term effects properly monitored with regard to the impact on market makers' willingness to commit capital where it didn't naturally exist in the marketplace. If it got to the point where they did not want to risk capital to maintain orderly markets, that could be detrimental in the long run. I would like to look back on these rule changes in six months to a year, to see the actual effect, as with any rule change. That strikes me as the prudent thing to do.

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