Some leaders in the trading community have stepped-up the fight against a central limit order book, the controversial system at the center of an integrated trading platform the National Association of Securities Dealers is hoping to implement.
On Dec. 22, the NASD sent a rule filing on the new system to the Securities and Exchange Commission for public comment.
The integrated platform, originally dubbed Next Nasdaq, has some traders hot under the collar. They view a central limit order book as direct competition.
"Most of us in the industry do not understand the NASD's rationale," said Bernard L. Madoff, chairman of the Securities Industry Association's Trading Committee. The committee is leading a push to have the limit-order-book proposal, as currently planned, scrapped.
Imprimatur
The proposed system initially received the imprimatur of Nasdaq's Quality of Market Committee, as well as approval late last year from the NASD board of governors. The system would create a single integrated order delivery and execution system, melding SOES and SelectNet functions. The central limit order book would not be mandatory.
At press time, Madoff was continuing his battle to have the central-limit-order-book proposal dropped. "One has a demonstrated need and is not controversial, while the other [the central limit order book] has a need yet to be demonstrated and is controversial," Madoff said.
Madoff added that the SIA recently met with NASD officials, presenting them with a proposal he said would satisfy the NASD's plan without compromising the market-making community. While some of the singular details are not groundbreaking, combined they are significantly different from the NASD's plan.
The SIA proposal would provide the ability to place orders into the market on an anonymous basis; allow limit-order execution capability for smaller broker dealers that have no special arrangements with wholesale market makers; provide market makers that don't want to display limit orders in their own quotes the ability to send the orders to other market makers or electronic communications networks; and finally, provide a system of last resort.
SIA Plan
Under the SIA plan, limit orders would first be transmitted into Nasdaq and then rerouted to market makers on a rotating basis. Market makers would receive a fee for putting the limit orders in their quotes. However, if no market makers display a transmitted limit order, Nasdaq's central limit order book would operate as a fail-safe system and display the limit order.
Madoff said this plan "would, in our mind, provide all of the services that the central limit order book would provide the industry, both for the buyside and the sellside."
"It would also have another advantage, allowing limit orders to be handled by market makers as distinct from an NASD system competing with them," he added.
While Madoff was hopeful that the NASD would consider the SIA plan, he acknowledged that he had no reason to believe it was acceptable to them. At press time, he had not received an official response from the NASD.
Voluntary
Meanwhile, many Nasdaq traders have echoed Madoff's criticism of the NASD's plan, targeting for their attack the so-called voluntary nature of the central limit order book.
Some predict market makers will lose order flow and have to protect limit orders they are holding for execution in the central limit order book. They contend that this could ultimately result in all limit orders being displayed in the proposed Nasdaq book.
One well-informed member of Nasdaq's Quality of Markets Committee, who spoke on the condition of anonymity, said there was disagreement on the committee about the proposal. "What drives me nuts is that it is hard to see the need for a new system," the trader fumed.
Madoff said wholesale market makers and regional firms view the proposed system as a real threat. Even the New York Stock Exchange, Madoff said, "has never done something like this, building a book bypassing their specialists."
The question remains: Why is the NASD strongly advocating a central limit order book? Individual-investor sentiment may be high on the list. For his part, Madoff feels the NASD wants to secure a "revenue stream." The Quality of Markets Committee member, on the other hand, views it as yet another example of the NASD "tripping all over themselves trying to make the SEC happy."
Indeed, a concern is pressure from the SEC to build strong electronic systems compatible with the highest standards of individual-investor protection. The NASD is under watch by the SEC in the wake of two governmental investigations, some sources stress. Certainly, no one wants to see Congress enter the fray. "It would be a mistake to involve Congress," Madoff said.
As for the renaming of Next Nasdaq, an NASD spokesman told a reporter, "It has a new name, but I have no idea what that name is. Look at the SEC filing."
