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October 14, 2009

Liquidnet Awaits Rule Changes

By Nina Mehta

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If the Securities and Exchange Commission revisits aspects of Regulation ATS this fall, as some expect, Liquidnet's exemption to the fair-access requirement could be on the chopping block.

Howard Meyerson, Liquidnet

Liquidnet's business could take a significant hit if its exemption disappears altogether. However, few expect this would happen without additional regulatory changes that would enable the crossing platform to keep doing business.

"Lowering the threshold [for us] would be problematic," said Howard Meyerson, general counsel at Liquidnet. "Our system is a useful way for institutions to reduce their trading costs. Telling institutions they have to go to block traders would set the market back 10 years and take away tools that institutions use to execute their orders efficiently."

Mark Wright, global head of product management at ITG Inc., which runs the POSIT crossing system and competes with Liquidnet, thinks its rival should not have its exemption yanked. "We believe many of the arguments Liquidnet put in its letter [requesting an exemption from the fair-access requirements]--about why certain dark pools should guard access to their pool and keep predators out to protect institutional customers--are useful," Wright said. "If the SEC changes the threshold, even in this day and age, the SEC would presumably still grant exemptions."

Liquidnet received a limited exemption to the fair-access requirements in September 2005 when the SEC lowered the threshold to 5 percent, from 20 percent, in connection with Regulation NMS. The exemption requires Liquidnet to provide fair and non-discriminatory access to trading in a specific stock on its platform if it executes 20 percent of that stock's average daily volume in four of the previous six months. All other alternative trading systems are subject to the SEC's current 5 percent threshold.

Reg ATS, which became effective in 1999, established a regulatory framework that enabled broker-dealers to create trading systems that competed with exchanges. It requires ATSs to disseminate their best priced quotes in a particular stock into the public quote stream once they reach 5 percent of the volume in that name. It also requires them to provide fair access to their markets once they represent 5 percent of the volume in a stock.

Liquidnet based its exemption request on the argument that it performed a similar task to upstairs desks seeking contra-side liquidity for buyside clients' block orders. Block desks are generally not subject to the fair-access rule. The firm also said that restricting access to only institutions was a key element of its business model.