Market Makers Blast the NASD's OTC Move
Gregory Bresiger
Market makers are protesting an NASD proposal for the over-the-counter market.
The NASD, as part of a plan to eliminate sub-penny quoting in the OTCBB, wants to rescind a rule that requires ECNs and ATSs to display access fees in their quotes. The move has the backing of a major ECN, but is opposed by dealers.
The change "will undoubtedly lead to a number of unintended dramatic consequences which will be detrimental to market participants and public investors," Knight Capital Group, the largest OTC dealer, told the Securities and Exchange Commission recently in a letter. "This will immediately cause an unlevel' playing field in the OTCBB market."
The debate has been raging since December when the NASD proposed to eliminate its Rule 6540(c). The four-year-old rule requires ATSs, including ECNs, to display their access fees in their quotes.
The NASD maintains it must kill the rule if it is to update another rule that sets the minimum trading increments for Bulletin Board stocks. Rule 6750 permits quoting in fractions as small as 1/256 of a dollar.
The NASD believes it must eliminate sub-penny quoting for stocks trading over $1.00 to conform with the thinking behind the SEC's new Reg NMS ruling. The SEC eliminated sub-penny quoting for stocks trading over a dollar in the Nasdaq and listed markets. The NASD believes the same principal should apply to the OTCBB market.
"The existing quotation environment," the NASD told the SEC last August, "can harm investors by creating a two-tiered market, one for ordinary investors and another for professionals."
In order to eliminate sub-penny quoting, however, the NASD believes it must also eliminate the access fee display rule. That's because access fees are typically quoted in hundredths of a cent.
At least one ECN-like ATS supports this move. "The NASD cannot ban subpennies and continue to require ATSs to display access fees when those access fees will be in sub-penny amounts," ArcaEdge, a unit of Archipelago Holdings, told the SEC last year. Otherwise, ArcaEdge contended, it would be discriminating among members.
Arca charges the original display rule was created in 2002 because of pressure from Nasdaq market makers who wanted to create barriers to entry for ATSs or ECNs.
ArcaEdge is one of three ATSs or ECNs to trade OTC securities. Track ECN and Knight's DirectEdge ECN are the other two. (Surprisingly, none of these ATSs actually display access fees in their quotes, according to Knight.)
ArcaEdge takes its case one step further. "There is no legitimate policy rationale for keeping Rule 6540(c) for the OTCBB," ArcaEdge told the SEC, "particularly in light of the Commission's recent adoption of Regulation NMS, which permits ECNs and ATSs to charge access fees in national market system securities."
Dealers disagree. A slew of the top traders of over-the-counter securities and their advocates have asked the SEC to stop the NASD from rescinding Rule 6540(c).
All say that chucking the rule would eliminate transparency, which would hurt investors.
"Simply put," writes STA Chairman Bill Yancey, "the access fees could conceivably exceed the price quoted on the security itself. It would only be after the transaction was executed that investors would know the full price with the added access fee," he wrote.
The dealers all say it would put them at a disadvantage vis-a-vis ECNs.
Hill Thompson told the SEC: "Permitting an ATS or an ECN to have hidden fees places market makers such as Hill at a competitive disadvantage to ATSs and ECNs, who will be permitted to charge non-subscriber hidden access fees, while market makers will not be able to do so,"
Hill supports the elimination of sub-penny quoting for OTC stocks trading over $1.00, but opposes the rescission of 6540(c).
Cromwell Coulson, chief executive officer of the Pink Sheets and who is sympathetic to market makers, put it simply: "This is an unfair practice."
A market maker official agreed that the passage of Reg NMS has re-opened the debate over whether these fee display requirements-which some ECNs have been able to get around by having private subscription agreements-should be ended.
"The problem is that Reg NMS, including the sub-penny restrictions, had a number of safeguards to prohibit abusive practices that we have seen over the years in Nasdaq markets such as high access fees, locked and crossed markets," according to the official who declined to be quoted by name. "The problem with 6540(c) is that it would eliminate some of the safeguards that Reg NMS has."
The market making official added that the elimination of the rule would lead to more locked and crossed markets, which would generate more fees for ECNs. Another market maker complained that the NASD didn't "understand the implications of this rule change."
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