Commentary

Jared Dillian
Traders Magazine Online News

Was it Worth It?

In this piece from 10th Man, author Jared Dillian discusses how the ETF revolution is less about ETFs and more about indexing; about how people have come to view stocks less as stocks and more as blobs of stocks.

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April 1, 2001

Third Market's Block Bonanza: Why the IPO Slump and Merger Activity Are Good For Off-Board Trading

By Peter Chapman

Also in this article

  • Third Market's Block Bonanza: Why the IPO Slump and Merger Activity Are Good For Off-Board Trading

Despite inroads made by electronic systems and the repeal of New York Stock Exchange Rule 390, business is good at the block end of the third market.

"The overall market has helped out," said Peter DaPuzzo, co-president institutional equity trading at Cantor Fitzgerald. "But even last year, when things got a little rough, we did enormously bigger business."

DaPuzzo says Cantor's third market trading has grown 35 percent in each of the last three years and is on track to do the same this year. Third market rival Jefferies & Company cites slower, but a still healthy growth rate of between 16 and 18 percent.

With two others - Jones & Associates and ITG - the two brokers dominate this niche business of crossing thinly-traded small- and mid-cap listed stocks off the floors of the NYSE and the American Stock Exchange. None of the four is a member of the exchanges.

DaPuzzo cites three reasons for the trading bonanza: the recent bull market, industry mergers, and the slump in initial public offerings. The bull market's contribution needs no explanation. The surge in mergers between broker dealers that hit a high last year means institutions are obligated to pay fewer firms for research. That lets them funnel more commission dollars to less expensive third market execution shops like Cantor.

DaPuzzo offers last year's takeover of Donaldson, Lufkin & Jenrette by Credit Suisse First Boston as an example. "If an institution did $1 million with each of those firms, it's unlikely to give the combined firm $2 million in commissions," he explained. "It might give them $1.5 million. So, there is another $500,000 worth of business now floating around."

Other recent deals between brokers servicing the carriage trade include UBS Warburg-Paine Webber; Chase-J.P. Morgan; ABN AMRO-ING Barings; and Goldman Sachs-Spear, Leeds & Kellogg.

The third reason for the trading bonanza, the collapse of the IPO market, means there are fewer deals to fatten the bottom lines of the buyside. Fewer deals mean fewer obligations to steer trading business to underwriters, both for the deals themselves and as payback.

"The window is closed," said DaPuzzo of the IPO market. "We make money because institutions don't have to pay back firms like Robertson Stephens, Alex Brown, Chase H&Q and Salomon Smith Barney. They have a lot of free' money to explore the third market and spread their money around."

On the flip side, potentially harmful market changes haven't caused third market traders to lose business, according to executives at Jefferies and Cantor. Last May, the NYSE and the six other stock exchanges, under pressure from the Securities and Exchange Commission, rescinded their rules that prevented member firms from trading certain names off-board.

Now, all of the large block positioners such as Goldman Sachs, Merrill Lynch, Morgan Stanley and Salomon Smith Barney are free to operate in the third market. John Shaw, president of Jefferies, doesn't think these firms will actively trade in the third market. "I'm not concerned," he said. "None of them have the network."