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Cincinnati Exchange Snags Some Business From Nasdaq

But a close look at the bourse shows that it doesn't pose much of a threat yet.


Cincinnati Stock Exchange

, a regional bourse that few on Wall Street used to watch, suddenly looks like a big player in



The exchange has snared roughly 10% of the daily share volume in Nasdaq-listed stocks, citing its "superior execution quality" and "innovative technology." And now the Cincinnati is angling to win



business as well. But the Nasdaq needn't get too nervous yet.

The Cincinnati's formula for success may have less to do with innovation than with the simple fact that it presents a convenient alternative for electronic-trading networks, or ECNs, that are opposed to the Nasdaq's newly launched SuperMontage electronic trading platform.

David Colker, president and chief executive of the 117-year-old Cincinnati exchange, disagrees, saying, "Everyone likes to say we're a one-trick pony, but every month we're adding new members." He points out that the exchange is lowering the cost of executing trades, but he also concedes that the exchange is heavily dependent right now on one upstart electronic-trading platform, Island ECN.

Currently, almost all of Cincinnati's share volume in Nasdaq stocks comes from Island, a platform that's favored by fast-fingered daytraders and some online brokerages. Back in February, Island stopped posting and recording its trades with Nasdaq and instead began sending its business to the Cincinnati. Island long has been a particularly outspoken opponent of SuperMontage, which made its official debut last month. Island executives claim SuperMontage -- which can post stock quotes from a variety of different trading platforms -- is an attempt by Nasdaq to drive it and the other ECNs out of business because they've stolen some of its market share.

Island's defection was a bit of a blow to the Nasdaq, which makes money from posting and reporting trades in its stocks. In the quarter ended Sept. 30, Nasdaq, for instance, took in $20 million in trade-reporting revenue, accounting for roughly 10% of its revenue stream.

And now the Cincinnati is looking to pick off even more of Nasdaq's business following Island's acquisition this summer by Instinet -- the granddaddy of the ECN movement.

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Instinet, which handles nearly 19% of Nasdaq's share volume, still posts its trades to Nasdaq. But like Island, Instinet is no fan of SuperMontage, and Cincinnati executives are hoping that Instinet decides to follow Island's lead.

"We are trying pretty hard to attract their business," said Colker. "We think this is the right place for them to be."

An Instinet spokeswoman said the company has no plans to alter the current arrangement. Nasdaq officials declined to comment.

If Instinet were to join Island on the Cincinnati, it could frustrate Nasdaq's plans to turn SuperMontage into the industry's main platform for trading Nasdaq stocks. It also could further complicate Nasdaq's much talked-about plans of going public.

Yet Cincinnati has plenty to worry about too. Right now, one of the big incentives behind's Island move to the Cincinnati -- other than Island's historic antipathy toward the Nasdaq -- is the subject of an inquiry by the

Securities and Exchange Commission


The original deal between Island and the Cincinnati involved a revenue-sharing plan, in which the Cincinnati kicked back as much as 75% of the revenue it made by packing and selling Island's trading data to other financial institutions. Island gave some of that money back to its customers in the form of a rebate that helped the ECN increase market share in Nasdaq stocks and the trading of exchange-traded funds.

But this summer, the SEC put the kibosh on a portion of that rebate plan, fearing it may create "incentives for traders to engage in transactions with no economic purpose other than to receive market data fees." The Cincinnati has applied to the SEC to reinstitute a more limited rebate program, but securities regulators have yet to act on the request.

Meanwhile, Instinet, in a recent corporate filing, reported that Island has "received a subpoena from the SEC for information regarding trading and market-rebate practices." The SEC inquiry, in part, involves an investigation into the trading practices of some of Island customers with regard to exchange-traded funds.

At this point, sources say there's no indication that the SEC inquiry is looking into any wrongdoing on the part of the Cincinnati or Island. But it's possible the SEC may not move on the Cincinnati's plan to reinstitute the revenue-sharing arrangement until the inquiry is complete.

Nonetheless, Instinet, in the corporate filing, said the inquiry "could have a significant adverse effect on our equity securities business." And anything that has an adverse impact on Instinet or Island's business could be bad for the Cincinnati, which historically has looked like a mom-and-pop operation compared to the Nasdaq or the NYSE.

Cincinnati officials say the exchange is profitable, but they don't provide any financial information, unlike the Nasdaq and the NYSE, which regularly post financial reports on their corporate Web sites. A 2000 annual report filed by the Cincinnati exchange with SEC reveals that before the deal with Island, the Cincinnati generated $6.3 million in net revenue and a profit of $613,664. Meanwhile, the Nasdaq during the first nine months of this year took in $615 million in revenue and generated $42.8 million in profit.

Rich Repetto, a brokerage analyst with Putnam Lovell Securities, said he doesn't see the Cincinnati posing any significant threat to the Nasdaq. "It's not like they are building a list of stocks," he said. Firms are "just listing trades there because of the market rebate."

The Cincinnati, which actually has been located in Chicago for nearly a decade, has 55 employees. Nearly half of the members of Cincinnati's board are former or current Chicago Board Options Exchange executives. The CBOE also has a significant ownership stake in the Cincinnati. In 2000, the Cincinnati paid the CBOE $2 million to operate its electronic trading system. The Cincinnati hasn't maintained a physical trading floor since the late 1970s.