June 1, 1999

Mr. Jonathan G. Katz
Office of the Secretary
Mail Stop 6-9 -- Room 6507
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: File No. SR-NASD-99-09
      File No. SR-NASD-99-16

Dear Mr. Katz:

Knight Securities, Inc. ("Knight") is pleased to have this opportunity to comment on File Nos. SR-NASD-99-09 (the "Agency Quote" proposal) and SR-NASD-99-16 (the "Agency Fee" proposal), proposed by the National Association of Securities Dealers, Inc. ("NASD"), through its subsidiary, the Nasdaq Stock Market ("Nasdaq"), to establish an agency quote display structure and to allow market makers to charge a fee when market participants access their agency quotes.

Knight is the leading market maker in securities listed in Nasdaq and on the NASD OTC Bulletin Board Service ("OTCBB"), trading in approximately 7,000 issues. In April, Knight's Nasdaq volume was about 3.9 billion shares for an approximate 10.2% market share, while its OTCBB volume was about 450 million shares for an approximate 25% market share. Thus, we believe the Commission will find our comments useful in its consideration of the Agency Quote and Agency Fee proposals.

For the reasons set forth below, Knight gives qualified support to both proposals but does not regard the Agency Fee proposal as a viable long-term solution to the inequities resulting from the fact that some electronic communications networks ("ECNs") currently charge fees to non-subscribers when their quotes are accessed, but market makers have not been able to do the same. Indeed, the notion of permitting a market participant to charge a market maker or other professional a post-transactional fee on top of his displayed bid or offer is incompatible with the manner in which our markets have functioned and will hamper best execution goals, cause confusion, and create significant administrative burdens and additional expense in the tracking and payment process. More troubling, these disadvantages will occur despite the fact that these fee charges provide no benefits to the market or public investors.

The Agency Quote Protocol

The Agency Quote proposal will allow market makers in Nasdaq National Market Securities ("NNM") to display in Nasdaq a second quotation, separate from their proprietary quotation, for the purpose of displaying customer limit orders. The second quotation - the Agency Quote - is supposed to facilitate the display and execution of agency orders in NNM securities. The NASD states that the purpose of the Agency Quote is to give market makers more flexibility in determining how they wish to handle customer orders and other agency business. Instead of having to display a customer limit order in their proprietary quote or in an ECN, market makers also would be able to display the order in their Agency Quote. In addition, the Agency Quote and Agency Fee proposals would allow market makers to charge fees when their customers' quotes are accessed, similar to what some ECNs have sought to do when market participants hit bids and lift offers that these ECNs display on the Nasdaq montage.

The Agency Quote proposal is designed to relieve some of the burdens and restrictions that the Order Handling Rules have placed on market makers. The Order Handling Rules, which were adopted in 1996, incorporated into Nasdaq some principles of auction markets. Specifically, the SEC adopted Rule 11Ac1-4 (the "Display Rule"), which requires market makers to display their customer limit orders that: (1) are priced better than a market maker's quote; or (2) add to the size of a market maker's quote when the market maker is at the best bid or best offer in Nasdaq. The SEC also adopted amendments to its Firm Quote Rule - Rule 1lAc1-1 under the Securities Exchange Act of 1934 ("Exchange Act") - which requires a market maker to make publicly available any superior prices that it privately quotes through an ECN by either: (1) changing its quote to reflect the superior price in the ECN; or (2) delivering better-priced orders to an ECN that disseminates these priced orders to the public quotation system and provides broker-dealers equivalent access to these orders.

Knight agrees with Nasdaq that the Order Handling Rules have affected the structure of the dealer market in ways that have created certain difficulties for market makers. As a result of the Order Handling Rules, market makers have lost a certain amount of control over their quotes because they must change their proprietary quotes to reflect certain customer limit orders held by them. Knight also concurs with Nasdaq's view that the Order Handling Rules sometimes make it difficult for market makers to work or negotiate institutional or block-size orders. As an alternative, a market maker may send a customer limit order to an ECN or another broker-dealer for handling, but, as Nasdaq recognizes, in those situations, the market maker gives away business.

Knight supports the Agency Quote proposal because it provides market makers with another mechanism for displaying customer limit orders which may, in turn, lead to a reduction in customer transaction costs. In addition, Knight supports the Agency Quote proposal because Knight believes that it is preferable to another NASD proposal to establish a Nasdaq Central Limit Order Book. (See File No. SR-NASD-98-17.) The SEC recently reopened the comment period on the Central Limit Order Book proposal, and in so doing stated that the Agency Quote was an alternative to the Central Limit Order Book. (See File No. SR-NASD-99-11.) For the reasons set forth in Knight's comment letter on the Central Limit Order Book proposal (dated May 21, 1999), Knight strongly opposes the Central Limit Order Book. Among other things, the Central Limit Order Book would place the NASD in direct competition with its own members for limit order business. While the Agency Quote is designed to serve some of the same purposes as the Centraal Limit Order Book, the Agency Quote does not pose the same threat to competition.

Post-Transaction Fees are Unacceptable

Knight shares the view of many market makers -- which view the NASD has acknowledged -- that it is inequitable for an ECN to charge a fee when someone hits one of its displayed bids or offers while market makers are prohibited from doing likewise. This prevents an enhanced liquidity provider from competing fairly with agency order handlers such as ECNs. The Agency Quote proposal seeks to address this inequity by allowing market makers to charge a fee when they act as agent, creating a more level playing field for market makers and ECNs alike.

The Agency Quote proposal, however, does not go far enough. For one class of broker-dealers (i.e., ECNs) to be able to charge fees when their quotes on Nasdaq are hit but not another class of broker-dealers (i.e., market makers), contravenes Section 15A of the Exchange Act in at least two respects. First, Section 15A(b)(6) of the Exchange Act says that the rules of the NASD shall be designed "....to remove impediments to and perfect the mechanism of a free and open market and a national market system.."and shall not be".... designed to permit unfair discrimination between...brokers, or dealers...." The fee assessments as contemplated by the NASD's proposal are impediments to a free and open market and unfairly discriminate between brokers and dealers. Second, Section 15A(b)(5) requires that the NASD's rules provide for "the equitable allocation of reasonable... fees, and other charges among members.using any facility or system which the association operates or controls." Permitting one class of NASD membbers to charge fees for executing through Nasdaq but not another, as this proposal would do, does not constitute an equitable allocation of charges among members.

Knight does not, however, believe that allowing both market makers and ECNs to charge post-transaction fees is the best way to structure the market in the wake of the Order Handling Rules. Among other things, NASD rules currently do not support the practice of charging fees to market participants who transact against bids or offers displayed on Nasdaq, and the NASD has not adequately addressed either the desirability or the legality of such fee assessments.

Historically, a market participant taking an offer on Nasdaq would pay the price on settlement and not expect to receive a statement sometime thereafter requesting a fee. Until 1997, the only bids or offers that could be inserted in Nasdaq were those of Nasdaq market makers who were subject to a number of affirmative obligations. Under NASD rules applicable to the Nasdaq market, market makers are required by law to give broker-dealers trades at the prices shown at their bids and offers. Nasdaq market makers currently do not issue after-the-fact statements for transaction charges to the broker-dealers who execute against their bids and offers.

Under the 1996 amendments to the Firm Quote Rule, a market maker must make publicly available any superior price that such market maker privately quotes through an ECN. A market maker is deemed to be in compliance with the Rule if the prices it enters into an ECN are publicly disseminated and the ECN provides equivalent access to other broker-dealers to trade at those prices.

In footnote 272 of the release adopting the Order Handling Rules, the SEC stated that, for access to be "equivalent", the ECN must enable non-subscribing broker-dealers to execute against the ECN's published best price to the same extent as would be possible had that best price been reflected in the public quote of the market maker. In the same footnote, however, the SEC added a contradictory statement that an ECN "may impose charges for access to its system, similar to the communications and systems charges imposed by various markets, if not structured to discourage access by non-subscriber broker-dealers."

Knight believes that it was improper for the SEC to have attempted to dispense with such an important issue in a footnote to the release adopting the Order Handling Rules. If, contrary to the current rules of the NASD, the SEC believed that ECNs should be permitted to add fees onto their quotes in Nasdaq, the SEC should have proposed ECN quote access fees as a new rule under the Exchange Act, allowing for Federal Register notice and public comment. Allowing ECNs to charge after-the-fact quote access fees is inconsistent with the established requirement that ECNs allow non-subscriber broker-dealers access to quotes that is equivalent to that provided by market makers. Knight does not believe that access to an ECN quote is "equivalent" if it is more expensive. In addition, the public should have been given an opportunity to comment on ECN quote access fees because they contradict NASD Rules 4613(b) and 4623.

Nevertheless, if the SEC allows ECNs to charge transaction fees, it should allow market makers to charge similar fees, whether their agency or their proprietary quotes are accessed. For this reason, Knight gives qualified support to the proposal to allow market makers to charge a fee in connection with the Agency Quote.

1Sec. Exchange Act Rel. No. 37619A, File S7-30-95 (September 6, 1996).

2Permitting ECNs to charge post-transactional access fees is also inconsistent with Section 11A(a)(1)(C)(i), which states that a National Market System goal is "economically efficient execution of securities transactions." These access fees impede the efficient execution of securities transactions.

3Rule 4613(b) states that a market maker who receives an offer to buy or sell from another broker-dealer must execute the transaction for at least a normal unit of trading at its displayed quotation as disseminated in Nasdaq at the time of receipt of any such offer. Rule 4623, applicable to ECNs that determine to display their best prices in Nasdaq, requires that ECNs allow any broker-dealer the electronic ability to effect a transaction with the ECNs' priced orders that is equivalent to the ability to effect a transaction with a market maker quotation in Nasdaq. (Emphasis added.) There are no exceptions to the rules that allow a broker-dealer, such as an ECN, to place a surcharge on the prices it displays in Nasdaq.

As a general matter, however, Knight believes it would be preferable to do away with after-the-fact transaction fees across the board. After-the-fact transaction fees are a cumbersome addition to the business of trading securities in Nasdaq. These fees have resulted in administrative costs -- for tracking fee expenses and paying bills -- that do not exist where market participants simply trade net at displayed prices. In addition, if post-transactional fees become standard, broker-dealers passing on these fees to their customers will need to redesign their confirmation disclosure forms to reflect the actual price the customer pays for the security (i.e., the execution price plus the fee). Moreover, allowing market makers to charge fees when their agency quotes are accessed, but not when their proprietary quotes are hit, threatens to put customer orders at a disadvantage. The fee assessment may be a disincentive to transact against customer displayed orders. Thus, the fee proposal seems inconsistent withh best execution principles.

Also of note, because of Manning obligations, a market maker would be required to execute against a displayed order of one of its customers if its own bid or offer (at an equivalent price) were hit first. Because of this, the ability of market makers to earn access fees on customer quotes under the Agency Quote proposal is substantially reduced and the purpose of permitting a fee charge is eroded.


Knight offers qualified support for the Agency Quote as an additional mechanism for the display of customer limit orders. In particular, Knight believes that the Agency Quote proposal is far preferable to the NASD's proposal to establish a Central Limit Order Book, which threatens to have serious anti-competitive effects. Knight also believes that the Agency Fee proposal should only be adopted as a last resort to address, at least partially, the inequity that results from the fact that ECNs, but not market makers, charge fees when their agency quotes are accessed. As a general matter, however, Knight believes that after-the-fact transaction fees are not a desirable addition to the securities markets. In our opinion, it would be more efficient to do away with such fees altogether and to require both ECNs and market makers to trade net, which we believe is consistent with the objectives of Section 11A(a)(1)(C)(i) of the Exchange Act.

4For the same reasons, customers of ECNs may not be receiving best execution for their limit orders. If an ECN customer seeks to sell at $10 and his displayed order is transmitted by the ECN to Nasdaq at $10 plus an after the fact charge of .01 to the buyer, then the customer's instruction to the ECN to sell at $10 is not being carried out because the buyer is required to pay $10.01.

Please do not hesitate to contact us if you would like to discuss these issues in further detail.


Kenneth D. Pasternak
Walter F. Raquet
Chief Operating Officer

Cc: Lee A. Pickard, Esq.
Pickard and Djinis