Abstract
Over‐the‐counter (OTC) trading thrives despite competition from exchanges. We let OTC dealers cream skim from exchanges in an otherwise standard Glosten and Milgrom framework. Restricting the dealer's ability to cream skim induces “cheap substitution”: some traders exit while others with larger gains from trade enter. Cheap substitution implies trading costs, trade volumes, and market shares are poor policy indicators. In a benchmark case, restricting the dealer raises welfare only if trading cost increases, volume falls, and OTC market share is high. By contrast, the restriction improves welfare when adverse selection risk is low. A simple procedure implements the optimal Pigouvian tax.