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June 1, 2011

OTC Markets to Become an ATS

By Peter Chapman

OTC Markets Group, as part of its ongoing battle with the Financial Industry Regulatory Authority, will transform itself into an alternative trading system. The company, formerly known as Pink OTC Markets, recently registered its OTC Link subsidiary as a broker-dealer with the Securities and Exchange Commission as a first step in a plan to establish itself as a regulated entity. The company plans to register OTC Link as an ATS and a member of FINRA later this year.

The move is intended to help the company upend plans by FINRA that could make it the sole collector of OTC dealer quotations, effectively eliminating the quote collection and dissemination services of OTC Markets. FINRA and OTC Markets compete to collect dealer quotes, which they then disseminate to the industry.

Cromwell Coulson

"The SEC asked us to register our interdealer quotation system as an ATS," said Cromwell Coulson, OTC Markets' president and chief executive officer. "So our operations will have their direct regulatory oversight."

OTC Markets operates a network that collects quotes from over-the-counter dealers and then sells them to market data vendors such as Bloomberg. It competes with FINRA's OTC Bulletin Board service. In recent years, OTC Markets has grabbed the lion's share of quote data as dealers opted to move much of their quoting away from OTCBB.

Of the 9,986 equity securities quoted in the over-the-counter market at December 31, 2010, 71 percent were quoted exclusively on OTC Markets' system, according to the company. Most of the rest were dually quoted. In the past four years, OTC Markets has seen the number of quotes on its system double while FINRA's OTCBB has lost three-quarters of its data.

In 2009, FINRA asked the SEC to be permitted to require market makers to submit their quotes to FINRA. That way, it argued, it could transmit a consolidated quote feed to brokers. OTC Markets, which already consolidates and disseminates quotes from the OTCBB with its own, has fought back. It risks losing those quotes as well as a sizable chunk of its revenues if FINRA prevails.

OTC Market's plan to register its OTC Link subsidiary as an ATS could make it easier for the SEC to reject FINRA's proposal. "It's a positive, long-term to be a regulated entity," Coulson explained. "Fitting ourselves into the regulated world, we can say we are an SEC-registered marketplace."

ATSs largely include exchange-like entities such as ECNS and dark pools. While they are technically broker-dealers, they share many of the functions of a regulated stock exchange.

OTC Markets actually has more in common with Nasdaq OMX before it became an exchange. For most of its life, Nasdaq was a dealer quote and trading service like OTC Markets. It was part of FINRA predecessor NASD, a self-regulatory organization.

Coulson says becoming a broker-dealer, as required by ATS regulations, will not change the firm's business model or its services. The company will not act as an agency broker as do most ATSs that operate as ECNs or dark pools. It will not charge per share or per trade execution fees, nor will it promulgate rules. "We are a network, not an intermediary, Coulson said.

If approved as an ATS, OTC Markets will become a member of FINRA. The two have set a deadline of May 23 for FINRA to process OTC Markets' membership application.

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