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September 30, 2000

Big Board Boasts Best Execution

By Laura Santini üInvestment Dealers' Digest

The NYSE is setting out to convince Wall Street and the public that it provides the best execution of any market.

The NYSE has released a working paper that explores a different measure of best execution: depth improvement.

Instead of price improvement, which means that an order gets executed at a price that is better than the national best bid or offer (NBBO), depth execution means that the institution is able to execute more shares than what's quoted at the NBBO.

Suppose an institution places an order to buy 5,000 shares, even though the best offer is for 3,000 shares. If the institution is able to get all 5,000 shares executed at the best offer price-due to dealings among specialists and traders-then the institution receives depth improvement.

"We are very keen on this measure and pushing it because we're concerned that penny spreads will reduce the depth of the quote," said George Sofianos, chief economist at the NYSE.

The exchange plans to meet with member firms and the Securities and Exchange Commission to discuss the validity of depth improvement as a measure of execution quality.

While the NYSE says that approximately 40 percent of all market orders receive price improvement at the exchange, its recent working paper claims that nearly 70 percent of all such orders achieve depth improvement at the NYSE.

What does this ultimately mean? The exchange suggests this depth measure should be factored into an assessment of price improvement, called adjusted price improvement. Take again the institutional order of 5,000 shares. Suppose the best offer is for 3,000 shares at 20. The institution may have to execute the remaining 2,000 shares at, say, 20 1/16. The volume-weighted price of the order is 20 1/40.

But suppose the institution gets more shares executed at the best price. If 4,000 shares, rather than 3,000, are executed at 20, and the remaining 1,000 shares are executed at 20 1/16, then the volume-weighted price of the order falls to 20 1/80, instead of 20 1/40. This provides a more accurate measure of best execution, the exchange argues.

Tim Heekin, head of trading at Thomas Weisel Partners in San Francisco, pointed out, however, that in today's market, traders have to assess prices available on competing private systems.

"Volume-weighted price doesn't encompass everything," Heekin said. "This market's gotten very fragmented, and you have to be cognizant of other trading opportunities out there."