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April 30, 1998

PaineWebber's Controversial Withdrawal From Regionals

By Michael L. O'Reilly

In a controversial victory for the New York Stock Exchange, PaineWebber closed all of the regional specialist units managed by PaineWebber Specialists.

PaineWebber had operated specialist units on the Cincinnati Stock Exchange, the Boston Stock Exchange and the Pacific Exchange, covering more than 500 stocks. In all, 35 employees were laid off with the closings. The firm will still manage its specialist unit on the NYSE.

PaineWebber declined to comment on the decision, saying only that it was part of an ongoing reevaluation of the firm's equity business. The firm will retain membership and continue to route orders to the three regional exchanges.

But the move by New York-based PaineWebber was significant in the heated rivalry between the NYSE and the regional exchanges over market share.

"The NYSE is absolutely recruiting business for their exchange," said David Colker, chief executive of the Cincinnati Stock Exchange, on the loss of PaineWebber. "I am concerned for the public investor that 85 percent of the trading in NYSE stocks is done in one place."

The regional stock exchanges function primarily as alternative sources of liquidity for NYSE-listed stocks. The regionals offer low cost structures and slightly different rules for investors looking to execute orders in listed stocks. More than 15 percent of volume in NYSE stocks is traded away from the Big Board.

Citing an interest in investor protection, the NYSE has lobbied with member firms for an increase in order flow. And in numerous instances, the Big Board has succeeded.

In 1995, brokerage giant Merrill Lynch & Co. closed their specialist operations on the regional exchanges, and announced their intention to route all listed orders only to the NYSE. The firm alleged it would get better prices for customer orders at the Big Board.

But Robert Jennings, a professor of finance at Indiana University who studied the move by Merrill, suggested that the firm may have received concessions from NYSE specialists for sending all orders to the NYSE.

"There was probably political pressure for Merrill to pull out of the regionals," Jennings added.

In 1996, the former Smith Barney followed suit. The firm - now a part of New York-based Salomon Smith Barney - closed its specialist operations on the Cincinnati Stock Exchange after sustained pressure from the NYSE.

And when PaineWebber made its announcement on April 16, it was not considered surprising. A source at the Boston Stock Exchange said the firm had given prior indication that it would pull out of the regional exchanges.

The source added that political pressure may have largely contributed to PaineWebber's decision. In fact, Joseph Grano, president of PaineWebber, has publicly remarked on the heavy recruitment made by the NYSE.

"He's [NYSE Chairman Richard Grasso] been yelling at me for three years, saying, 'What are you doing, the order flow should be coming to the primary market,'" Grano said in an April article in the Wall Street Journal.

Nevertheless, Grano has denied that PaineWebber's decision was influenced by Grasso's lobbying or political pressure.

Tumult

Separately, PaineWebber has displayed a tumult within its own equity operations in recent months that suggest a reevaluation of operations.

In November, seven Nasdaq traders left the firm, including head trader Richard Bruno. PaineWebber refused to comment whether the resignations were forced or voluntary. Patrick Davis and William Heenan succeeded Bruno as co-heads of over-the-counter trading. Just two months later, Heenan left the firm to join the Nasdaq desk at Donaldson, Lufkin & Jenrette in New York.

And over the last 12 months, the firm stopped making markets in more than 200 Nasdaq stocks, cutting its list from 735 to 525.