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June 30, 2000

Will Regulators Botch Market Structure?

By William Hoffman

Few things can send investors heading for the hills faster than an offer of help' from Congress.

But Dennis C. Hensley, counsel to the New York law firm of Brown & Wood, LLP, thinks Washington's current interest in market fragmentation could ensure U.S. dominance of world finance into the 21st century.

"These are very exciting times and very challenging times," said Hensley, a former chairman of District 10 of the National Association of Securities Dealers.

In his current post, he advises broker dealers and market makers on regulatory enforcement and market structure issues.

Hensley thinks the U.S. securities industry may look back on the year 2000 as the moment when the groundwork was laid for an effective, streamlined and investor-friendly structure flexible enough to compete on world markets.

On the other hand, Congressional and regulatory interference might also have the opposite effect, costing U.S. securities exchanges their leadership position, Hensley said.

Demutualization of exchanges, new technologies, crises in Asia, political and economic consolidation in Europe present unique challenges for U.S. markets and their watchdogs, Hensley believes.

In the Trenches

A trading executive said the regulators and congressional leaders are aware of the challenges. "I get the impression they are trying to understand the dynamics that have driven us to this point," said Mike Molnar, president of, in New York, an affiliate of Houston's Momentum Securities.

"I don't think fragmentation is necessarily a bad thing," Molnar added. It should be viewed as a transitional period in the evolution of U.S. markets, toward a more transparent, efficient, speedy, and reliable new structure, he said.

The last major reforms were enacted in 1975. But the result, Molnar and Hensley agreed, could be the same: better prices and more competitive U.S. markets, if government can resist the temptation to lay a heavy, intrusive hand on the more natural evolution of exchanges and financial markets.

Technology may soon allow each stock order to be assessed individually, against all the nation's markets for the best price, as was envisioned during the last major push for transparent market structure in 1975. "But we're not there yet," Hensley said.

Hensley and Molnar did not appear anxious about Congress and the regulators doing something stupid. Molnar said the Securities and Exchange Commission seems to be resisting extremes, from a fully-centralized limit order book, to a truly fragmented market of incompatible and incommunicative exchanges.

"I think [government would] like to see more free market forces at work, which makes sense," Molnar said.

Hensley noted that the SEC's recent concept release on market fragmentation shied away from specific recommendations.

Not to say there aren't fragmentation issues to address, both agreed. Molar argued that Washington must understand technology as a catalyst for enhanced transparency and neutrality, which are essential to assuring the goal of best execution.

Flexible Approach

Hensley said regulators also need a more flexible approach to suitability standards in diverse markets. These range from the online trading community to old-fashioned portfolio managers who meet weekly or monthly with hands-on investors.