The SEC's Balks, But Reuter's Instinet Still Keeps Its Cards Hidden

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Like a steamroller, new rules on the Nasdaq stock exchange were designed to level a notoriously uneven playing field this week. But the steamroller may have missed a big bump. Some Wall Street traders are up in arms over a little noticed exception to those rules which allows market makers to secretly disguise the size of those orders. This trick is a part of proprietary


system, owned by


(RTRSY:Nasdaq ADR), and known as the Reserve Book.

The Reserve Book allows market makers using Instinet to list a sale of only 1000 shares of a given stock, despite that fact that the true order might be for many thousands of shares. That order size may represent a significant shift in the market, but will be hidden to the average investor. This advantage, given only to Instiniet users, is akin a poker game where only one player gets to hide his cards. So far the new rules only affect 50 of the busiest stocks on the Nasdaq, but eventually they will be applied universally.

"Instinet reserve is totally ridiculous," says George West, Jr., president of Broadway Consulting Group, a New York firm involved in SOES trading. "With these new rules, everything is supposed to be out in the open--but Instinet just won't do it. It runs completely counter to the openness and fairness that the SEC has demanded."

John Heine, a spokesman for the Securities and Exchange Commission, would not comment on the apparent Instinet loophole.

Instinet is a tremendously important asset to Reuters. Some estimates have Instinet responsible for more than 35% of all trades on the Nasdaq (or TK trades on today's volume) before the rule change went into effect. And Instinet is also the most important engine for earnings growth of Reuters. The company reported on July 25 that revenues for it's transaction products group--primarily Instinet--was growing at a 28% clip.

Since the implications of the Nasdaq rule changes have become clear, Reuter's stock has been clobbered. Shares in the company's ADRs have dropped on heavy volume from 76 on January 1 to trade as low as TK today.

Traditionally, Nasdaq market makers publicly quote two prices for stocks: a price being bid to buy a stock and a higher price being asked to sell the stock. But with Instinet market-savy traders have also had the ability to buy and sell at better, "unadvertised" prices. Joe Q Public was been excluded from this process and had to buy at the higher "advertised" Nasdaq "ask" price, and sell at the lower "advertised" "bid" price.

In other words, there were better prices available to insiders than to the general public. In theory, that means your broker could have sold you a share of


(NETC:Nasdaq) for, say, $13 1/2, but only played $13 for it.

The SEC was not at all fond of this system and on Aug. 8, 1995 the National Association of Securities Dealers was censured for failing to halt widespread price-fixing. Rule changes were essentially forced down their throat and Nasdaq chairman Alfred Berkeley has overseen the creation of the new rules to try to make the Nasdaq more fair and open.

But some charge that a fair and open market would put Instinet out of business. "I think Instinet tried to keep as much of the status quo as they could," says Michael Nevitt, a market maker with NDB Chicago. "But it's only been three days, so we'll see how this plays out."

by Cory Johnson