The rules under consideration would require Nasdaq dealers to give customersthe benefit of any prices that the dealers obtain by trading before theregular 9:30 a.m. EDT opening. Currently, that obligation doesn't ordinarilyexist.

The proposed rules, outlined in a memo from Nasdaq to its Quality of MarketsCommittee, appear to reflect a concern that dealers, by trading before theopening, may be taking advantage of their knowledge of investors' tradingintentions, sometimes at investors' expense. For example, a dealer with manybuy orders of a stock might snap up shares before the opening, then sellthem at a higher price to investors at the opening.

"Nasdaq staff have recently become aware of certain practices in thepre-market that it believes adversely impact public customers," says thememo to the committee, which is Nasdaq's top advisory panel onmarket-structure issues and is made up of brokerage and institutionaltraders.

Some brokerage firms are using information about orders their customers wantexecuted at the 9:30 opening to trade before the opening, then fill those"queued customer orders at the open, at prices significantly above thefirm's pre-market purchase cost," the memo states.

The memo, dated March 20, followed a page-one article in The Wall StreetJournal several weeks earlier about Knight/Trimark Group Inc., Nasdaq'sbiggest dealer, or market maker. The firm, based in Jersey City, N.J.,executes hundreds of thousands of orders a day sent to it by online anddiscount brokers.

The article described, among other things, how Knight uses knowledge of itscustomers' order flow, including pre-opening orders, to aid its proprietarytrading. But it also noted that Knight's brokerage customers praise thefirm's service, speed and willingness to use its capital to quickly giveinvestors the best price on a stock anywhere.

Richard Ketchum, who is president of the National Association of SecuritiesDealers, which runs Nasdaq, said Tuesday: "We are seriously looking at thetrading rules governing the opening. But I can't comment on anything inparticular because there isn't a hard proposal at this moment."

The memo made no mention of any particular firm. But people familiar withthe committee's deliberations said the issue arose because of the attentionfocused on Knight, though other dealers often engage in similar activity. Kenneth Pasternak, Knight's CEO, said he was unaware of the proposals,but bristled at the suggestion that his firm's activity comes at investors' expense. "We don't make any money off the pre-opening," he said, and infact the firm, though highly profitable overall, regularly loses money atthe opening by guaranteeing the opening price to all eligible orders.

"We're trying to add value, not detract value." It's the customer, notKnight, that has the edge, he says. "The customer chooses when we trade, atwhat price we trade, at what [share amount] and at what time."

The memo describes a hypothetical situation in which a market maker - adealer who quotes bid and offer prices at which he will trade withinvestors - has received 500,000 more shares of buy than sell orders to beexecuted at the opening. Using this information, the market maker buysshares before the opening, placing bids at successively higher prices,sometimes at or above another market maker's offer price (an anomaly knownas "locking" or "crossing" the market). "At times the member willlock/cross the market without trading, which raises concerns ofmanipulation," the memo says.

It buys 500,000 shares at an average price of $21.50, then sells thoseshares to customers at an opening price of $23.0625 apiece, profiting fromthe difference. "Nasdaq believes such activity is not in the best interests of public investors or the quality of the Nasdaq market," the memo says.

The memo makes two proposals. The first is to require that a market makerthat holds both a customer's limit order (an order that can be executedonly within specified price limits) and a same-priced in-house order foritself, fill the customer's order first. That obligation, known as theManning rule, already exists after 9:30 a.m., but the memo proposes itbegin at 8:30 a.m. The second proposal is that market makers givecustomers' market orders (which are to be executed at the best availableprice) the benefit of any prices it obtains trading before the opening.

Mr. Pasternak says his firm already applies the Manning rule to all itscustomers' orders, but those orders generally aren't eligible for executionbefore the opening. If they were, Knight would extend Manning protectionto them as well, he says. He added that a market maker is taking on riskwhen trading before the opening, since the price can move against it, andcustomers can cancel their orders before 9:30.

-- The Wall Street Journal