<<Now Knight's letter complains that it sold, presumably via automatic execution, 900 at 1/8 to an E*Trade buyer. I don't understand how the ISLD offer would cause NITE to sell at a price lower than NITE's posted offer. Likewise (although I've omitted the projected Level II display) I don't understand how the subsequent ISLD bid at 71 3/8 comitted or caused NITE to buy 900 at that price.>>
A very good post, brec. NITE said it had to sell 900 shares at 1/8 (the inside offer narrowed by ISLD) to an Etrade customer because it had automatic execution (probably for size 10 and under) agreement with Etrade in exchange for order flow. I believe Knight was just using this as example to attack ISLD, but in reality the Knight mm would likely take out ISLD's offer at 1/8 size 1 first (can use REDI or Brass to hide identity, INCA is too slow), within a second or two, the inside offer would be back to 1/2. NITE could fill the customer's 900 shares at 1/2 then. It's frontrunning, but for size 1 and size 9, regulators would not have time or resources to investigate it.
A better way would be for NITE to program its TOOL to direct the first 100 shares of the Etrade customer's to ISLD, taking out the offer at 1/8 instantly, then proceed to fill the remaining 800 shares at 1/2. This is perfectly legitimate -- they just have to use the right software TOOL, which I am sure they have at their disposal.
The same reasons apply to the 3/8 bid size 1 bid from ISLD, in reverse sequence.
Moreover, the autoexec agreement was between Etrade and NITE, and no one stuck a gun to NITE's head to agree to it.
Final summary, within the confine of this example, NITE is full of it.
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