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November 1, 1999

Levitt's Legacy: Fragmentation or Centralization. Will Arthur Levitt Find the

By John A. Byrne

The montage system is different. Dealers could voluntarily send multiple agency and principal orders anonymously or with a market maker attribution at multiple price levels. Nasdaq said it would redesign its dealer workstations to incorporate a window for the montage at the top. Two other windows underneath would carry the current workstation features, in addition to a designator for the size of orders sent to the montage system.

The top window, known as the Order Display Window, would show the inside market on Nasdaq, followed by two price levels below. A separate reserve size feature would replenish a participant's displayed size order once that order is decremented to zero.

While the montage responds to Levitt's call for more centralized markets it does have a drawback, according to critics. ECNs would see their current business model crimped. That flies in the face of the type of competition Levitt might see as necessary.

"Where is the redeeming social benefit of the super montage?," said Kevin Foley, president of Bloomberg Tradebook, "Nasdaq does not mutualize risk and guarantee the other side of a trade like other ECNs."

ECNs come out looking wounded under the super montage proposal, which was sent to the SEC for publication in the Federal Register. But ECNs aren't about to switch off the lights.

"I see ECNs as the small technology boutiques of financial services," said Arthur Pacheco, president of STRIKE Technologies at the STA's Palm Desert conference. "They are small and they don't have huge infrastructures. They are flexible and innovative and technological change will probably be driven by these small boutiques."

ECNs could see some drying up of revenue streams under the super montage proposal. The planned facility would effectively operate as an ECN sponsored by Nasdaq. At the same time, Levitt has publicly stated that he thinks ECN access fees for non-subscribers are unfair. What that ultimately means is not clear.

Dealers, on the other hand, stand to reap transaction revenues by providing liquidity to the montage system. So do ECNs but they are unlikely to have the same enthusiasm as dealers for sending limit orders to a competitor. Dealers would also be empowered to automatically execute agency and principal orders in a consolidated SelectNet and SOES system.

One ECN executive, speaking on the condition of anonymity, sees trouble brewing. He said current ECN subscribers will be tempted to develop pipelines to allow them to access ECNs through a gateway built for non-subscribers.

Already, the talk sounds a little like what Levitt does not have in mind. "What we need is a central limit order book for equity trades," said Peter Jenkins, head of equity trading Scudder Kemper Investments in New York, stressing that he hasn't fully studied the super montage proposal. "[The institutions] called for a CLOB in the past and nothing has changed."

Dealers, including industry activist Bernard Madoff, a principal at Bernard L. Madoff Investment Securities, have so far supported the super montage proposal. Lee Korins, the president of the STA, said that on the surface the proposal was a step in the right direction.

"The problem is Nasdaq keeps coming up with the proposal of the year and then the next day its network shuts down," said Korins, referring to an outage on Nasdaq in early October. "The question is, has Nasdaq the technology platform to pull [the proposal] off?"

Nasdaq and the NYSE are planning to fight competitive technological currents with deep infusions of capital, having taken steps on the road to becoming for-profit companies. Both exchanges see tantalizing franchise opportunities overseas. The SEC is not standing in the way.

Levitt noted, however, in his Columbia Law School speech, that "progress has sometimes been frustrated by narrow interests and that's when it's been necessary to invoke pragmatic regulation."

His legacy may not please everyone.