FROM DISS TO CONNECT: TRASH-TALK E-FIRMS EYE AN ALLIANCE: NETWORK MAKING NICE WITH MARKET MAKER

Two of Nasdaq’s biggest operators — and biggest bad-mouthers of each other — are reassessing their relationship.

Knight/Trimark Group, Nasdaq’s top market maker with almost a fifth of the market’s transactions, and Island ECN Inc., a popular electronic communications network, hint they may form an alliance to capitalize on the continued explosion in online stock trading. A deal could mean faster execution and cheaper trades for investors.

Says Kenneth Pasternak, CEO of Knight, “I wouldn’t preclude hooking up with Island.” That’s the company he once called a rowboat in a sea of exchanges. Now he says, “We’ll process order flow into whatever entity can provide both investor protection and execution outcomes that are beneficial to customers.”

For his part, Island CEO Matt Andresen, despite the fact that he likens market makers to “used car salesmen,” says: “Partnering with Knight is certainly something both parties would consider. Its service is, in many ways, a perfect complement to the service Island provides.”

He’s right.

ECNs match buyers and sellers online for a commission. Proponents say they cut costs by eliminating the broker and the exchange. Buyers can simply visit Island’s website to see what’s for sale; sellers can post their offerings and wait for a buyer to meet their price.

The downside: lack of liquidity. It’s like a dating service that introduces prospective partners but guarantees nothing. If a match isn’t made, an investor can become a wallflower, waiting, waiting, waiting for a buyer or a seller.

Market makers, on the other hand, exist to guarantee liquidity, risking their own money on each trade and insuring that there’s always a supply of the stock they specialize in.

Part of Knight’s allure is the volume of trades it conducts and the number of stocks it holds: at least 850 shares of each of the 6,000 NasFrom diss to connect for e-firms

daq issues. With that kind of liquidity, more and more people flock there.

Moreover, the Jersey City, N.J., brokerage sits atop $350 million in shareholder dollars, enough to let it trade quickly and flexibly at a marginal profit.

A deal with Island could help Knight boost its 306,000 daily transactions by as much as 17%. An Island spokesman says in the first quarter 5.5 billion shares were traded through the service, which averaged roughly 200,000 transactions daily.

A partnership would also give Island the liquidity it lacks — “a huge problem at the open” of the market each day, Mr. Andresen concedes.

It’s too soon to say what will happen, but as Amar Mehta, equity analyst at CIBC Oppenheimer Corp. in New York, says, a strategic partnership between the two would be “explosive.”

executioners strong

BancBoston Robertson Stephens senior analyst Scott Appleby agrees: “Both players continually gain market share, and both offer customers good execution. But the best execution incorporates both of their models.”

Perhaps more important: despite their successes apart, neither is guaranteed continued business from their brokerage customers.

Even some of Knight’s owners, including E*Trade Group Inc. and Waterhouse Investor Services, a unit of Toronto-Dominion bank, have invested in ECNs. E*Trade spent $25 million for a 25% stake in ECN Archipelago Inc. in January and this month Waterhouse paid $25 million for a 12.5% stake in Island.