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December 1, 1999

Is the Reform Worse Than the Problem? A Stock Market Chief Takes a Second Look a

By John A. Byrne

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Without modern computers, the implementation of the order handling rules would not have been possible. Think about it.

The order handling rules have been single-handedly credited with leveling the playing field. Technology enables customers' limit orders to be electronically disseminated and made transparent. Back in the 1950s, or even in the 1960s, that would not have been as easy. (Conversely, allegations of unfair trading practices on Nasdaq arose because traders were said to be perpetrating abuses - on a computerized dealer market.)

But the question arises, is the regulation of fairness for investors bound by the technological advances of the late 20th Century? The conventional wisdom on Wall Street - and across Main Street - is that technology has unleashed unprecedented opportunity for the little guy? But is the little guy better off?

Steve Wunsch, the founder and president of the Arizona Stock Exchange, the struggling call market run out of New York City, says the answer is no.

The little guy, he argues, has been used as an excuse by the regulators to re-engineer the U.S. stock markets, causing these disruptive consequences: uncontrollable volatility, massive price manipulation, a dearth of liquidity and a breakdown in price discovery. In such an environment, Wunsch claims, the reputed reduction in transaction costs created by "leveling the playing field" is eliminated.

"The academics and regulators, in a sort of mutual admiration society, have spun theories that don't hold water," Wunsch, the former head of the stock index futures department at the now defunct Kidder Peabody, states in a pamphlet he recently published. "Settled doctrine or not, it makes no sense to turn the stock market into a testing laboratory for anyone's theories. But the fact is that, after all the tinkering, the academics and regulators have become the chief designers of the stock market today."

In a telephone interview, Wunsch is even more outspoken. "The order handling rules and the National Market System [enacted by Congress in 1975] are designed to ensure the retail guy has the same opportunity as Salomon Brothers," he said. "But that is exactly what Marx tried to do"

Here is what Wunsch thinks: Centralized markets, organized around membership-owned stock exchanges are good for the investor. Centralized markets encourage profitable intermediation and healthy stock exchange monopolies. Centralized markets encourage upstairs discussions among dealers about order flow and the discovery of good prices based on those flows. Too much regulation is bad.

"Because the [order handling rules] require that all electronic communications networks be allowed to free-ride on each other's and the general market's liquidity through SelectNet, the concept of proprietary liquidity on a market whose members are loyal to it is already out the window in the Nasdaq market," Wunsch states. "Once ECNs become exchanges, as several plan to do, this situation will also apply in NYSE-listed stocks."

Wunsch's provocative opinions are unpopular, especially among the buyside.