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February 1, 2000

Washington Watch: Internet Brings Competition to Big Board

By William Hoffman

Is the New York Stock Exchange's floor- based auction about to be replicated in cyberspace? That's the hope behind the Primex Auction System and its Nasdaq partner.

The new venture expects to do for offboard trading what Bernard L. Madoff Investment Securities did in the early years of the third market - siphon order flow away from the Big Board.

But there's a possible snag: some exchange-floor functions can't be replicated by computers, a visiting economist at the NYSE contends.

"Whether or not people can make a better NYSE with software, they are going to try," said Lawrence Harris, a finance professor at the Marshall School of Business, University of Southern California. Speed and efficiency are important to modern stock markets, Harris added, but so are trust and reputation.

The Nasdaq stock market announced on Dec. 9 that it had signed a letter of intent with Primex Trading N.A. The venture plans to execute listed and Nasdaq orders at prices better than the national best bid or offer, starting this summer. Market makers, order-entry firms, electronic communications networks (ECNs), and others will anonymously submit customer orders into an electronic "crowd" (consisting of brokers, dealers, and sponsored institutions). The backers of Primex include Bernard L. Madoff Investment Securities and Goldman Sachs.

The Nasdaq announcement came on the heels of a December vote by the NYSE board to repeal Rule 390. Rule 390 prohibited NYSE member firms from trading NYSE securities listed before April 26, 1979 away from a traditional listed stock exchange. That directive covered 23 percent of listed stocks, comprising 46 percent of the NYSE's volume, according to a recent statement by Chairman Richard Grasso.

The NYSE was not interested in discussing the impact Primex might have on its listed stocks and trading volumes. "I'm just going to decline to comment," said Ray Pellecchia, spokesman for the exchange. Still, the NYSE is not sitting on the sidelines. The exchange has taken steps to introduce web-based trading systems, including an order book that would provide member-sponsored direct execution for orders of 1,000 shares or less. Roger Madoff, a spokesman for Primex, refused comment, pending completion of the final agreement with Nasdaq.

Nasdaq's alliance with Primex could expand that exchange's opportunities for off-board trading of NYSE-listed securities, Harris said. The NYSE "is not a very fast market," he said, noting that systems like Primex could offer services such as on-demand order cancellation or confirmation that the NYSE is not now well-suited to deliver.

But slowness is not always a bad thing in securities exchanges, Harris insisted. The exchange floor is a liquid market, where participants can do things they might not be able to do elsewhere, he said.

Further, a trader wants information on the market that may not be immediately apparent to a machine. Floor-based exchanges like the NYSE offer advantages of institutional memory, judgement, and human interaction, Harris said. "Those relationships cannot be easily duplicated by computers," he added.