Via email and overnight delivery
Jonathan Katz, Esq.
Re: Release No. 34-48501; File No. SR-NASD-2003-128; solicitation of Comments
Dear Mr. Katz:
It was with some alarm that we read the captioned Release describing the recent rule change proposed by the NASD.
We offer our comments and observations, in the hope that a significant and obvious inequity can be averted.As has been clear ever since the Proposal of SuperMontage, the NASD and its subsidiary, NASDAQ, have been making concerted efforts to minimize the competitive ability of ECNs, in a painfully obvious effort to revive the flagging market share of NASDAQ and to create of it a “Super-ECN”.
It is difficult to avoid the fact that although the NASD is “in the process,” of divesting its interest in NASDAQ, that divestiture remains uncompleted, at a time when NASD is proposing an arbitrary rule change, which clearly hurts ECNs and helps NASDAQ. It is unthinkable in any other free-market situation that a regulatory agency with such a glaring conflict should be in a position to create rules which impact the competitors of its subsidiary.
Assuming, but not admitting, that current ECN fees are too “variable” we are obliged to note that in the context of this Release, “variable” can only be a metaphor for “too high,” because if the only goal of the rule were to rationalize rates, it would be more rational to set the cap at .009 and allow smaller ECNs to a) generate sufficient income to remain in business and offer more attractive rebates to generate even more liquidity (for example, from institutions, large individual investors or similar large pools of liquidity, who would be encouraged by the opportunity to earn more); or b) to charge less if they so chose-as the proposed rule clearly indicates would be the ECNs’ choice with the .003 cap.
Pursuing the NASD’s argument to its logical end, if the goal is to inform the “user” network of the maximum fees charged by ECNs, there is, once again, logical inconsistency in the rhetoric. If the word user refers to dealers, it is ridiculous to believe that there is even one dealer who is not fully aware of the charges levied by every ECN as well as the rebates available. If, on the other hand, by user the Association means the public, the argument, once again rings false: the public is never generally aware or informed of such charges any more than they are generally aware of New York Stock Exchange floor brokerage fees. For the reasons noted above, the goal of “full awareness” is better served by placing the cap at the higher end of the scale. Any other interpretation is specious and fallacious and must be viewed as serving the alternative agenda of resuscitating a quickly declining NASDAQ market at the expense of small ECNs. It is transparently obvious that competitive market forces would either drive the excessive fees down to an equitable level or drive those who levy excessive charges out of business. The market tells us that this has not been the case with ECNs. If any entity continues to lose market share it is NASDAQ. The reason for this loss is crystal clear: as long as the ECN fees remain below one cent (which the NASD itself vehemently maintains is the minimum quotation increment it will support or allow in the decimal environment), a client will always receive the best execution, even including the ECN fee, so long as the ECN quotation is better than the next highest quote (which must, perforce, be at least one cent higher). As a point of historical fact, when a previous SEC Economist was asked to find a flaw in this thesis, he was unable to do so. Of course this observation does not even begin to address the question of liquidity where the contribution of ECNs is palpable and obvious. Finally, the NASD’s observation that potential users are “discouraged” from using the System by the inability to anticipate costs due to the “gross fee disparities” (SEC Release 34-48501, Federal Register /Volume 68, No. 189/Tuesday, September 30, 2003/Notices, at page 56360; A. Self-Regulatory Organization’s Statement of the Purpose for, and statutory Basis of, the Proposed Rule Change; 1. Purpose, first and Second Paragraphs), is simply made up of whole cloth. The robust volume figures even in the recent, disastrous market environment, clearly exposes this statement as a painfully obvious Non sequitur.
We also notice that the release is devoid of any factual basis, which supports the three-mil cap as a reasonable one, other than by pointing out that this is precisely NASDAQ’s fee structure. Although this reasoning is geometrically sound-insofar as it is perfectly circular, we are unable to find any evidence of a rational consideration of any particular number. It is an ominous admission that the proposed fee would merely grant NASDAQ a competitive advantage that it would not otherwise enjoy. Such arbitrary price-fixing would raise an enormous groundswell of outrage in any other context. It is antithetical to the most basic tenets of business and carries with the potential for actual public harm.
If small ECNs (the competition) are driven out of business, then nothing prevents the sole remaining sources of liquidity from raising prices (or widening spreads) because there is no place else for the consumer to go. The most rational rule change is to set the cap at 9 mils This would serve the dual purpose of “avoiding unknown variables while, at the same time, allowing the small ECNs to remain in business while continuing to perform their vital functions of providing liquidity and offering alternative execution facilities.
It would seem that NASD and the SEC are ignoring the fact that the market has so obviously been demonstrating: that the NASDAQ model simply is not viable, and are making all efforts, disguised as benefits for the investing public, to “bail out” a business model which would otherwise collapse of its own weight. All to the detriment of small ECNs, which are also declining in number-not because of inefficiency, quite the contrary, the volume figures clearly demonstrate that the investing public finds these entities a useful and preferable alternative to NASDAQ-but because of rule-making designed to salvage the NASDAQ market by forcibly and knowingly squeezing small ECNs out of business. These are the very same small ECNs who have helped to add liquidity and rationality to the market (we remove from this equation “large ECNs”- those primarily owned and supported by the order flow of “Mega-broker dealers with huge market making operations, because of their obviously merged goals with NASDAQ of eliminating the competition of small ECNs).
Given the recent (and horribly expensive to the public) regulatory fiascos such as accounting, research and unscrupulous market-making, the SEC would be better served by focusing its talent and resources on the genuine problems rampant in the securities industry, rather than giving in to political pressure to bail out a non-viable entity at the expense of the very entities which help to keep negative market influences at bay.
The proposed rule change is not problem solving, it is sowing the seeds of disaster.