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November 1, 2001

Hurting The Little Guy

By Harold Bradley

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  • Hurting The Little Guy

A distinguished market structure scholar has described the New York Stock Exchange as a sort of "historical accident." If the Big Board was redesigned today, he suggests, it would not start with a floor, it would start with an electronic platform. Richard Grasso, the Big Board chairman disagrees, saying that blending human traders and technology "in terms of providing services to customers" is the best solution.

The Securities and Exchange Commission has attempted to resolve this apparent conflict through the adoption last year of Rule 11Ac1-5. This requires market centers to report each month a standard set of statistics that measure execution quality for small-order customers. The Big Board did not fare well in the first month's reported data. In key measures of effective spread and speed of execution, it indicated relatively poor performance for the Big Board. The exchange, deflecting possible criticism, explained that results may have been compromised by the exclusion of institutional blocks' exceeding 10,000 shares.

This is a surprising irony for an exchange that promises price improvement' for house painters and school bus drivers,' a promise it uses as the pretext for internal rules and policies.

For many years institutions have complained that many of these same policies undermine the primacy of limit orders on the exchange's own book and the interests of the other little guys' who choose to invest in mutual funds.

The intermediation imposed on customers of the NYSE carries high costs and perhaps illusory benefits, according to several studies. In fact, its physical structure represents a visible single point of failure' in our financial system.

The Nasdaq market, on the other hand, experienced dramatic change when rules adopted in 1997 forced ECNs to include orders in the public display of the National Best Bid and Offer (NBBO). Despite complaints from both ECNs and dealers about access fees' charged to ECN counterparties, large and small investors today enjoy the benefits of direct, anonymous and speedy access to Nasdaq orders.

But so far, listed-securities markets and ECNs have forestalled the extension of the order handling rules. Regulators cite the access fee conundrum as impeding the unfinished business' that would drive ECN listed order flow into the public quote.

Only Archipelago ECN displays its listed equities business in the NBBO through the ITS-CAES link offered by Nasdaq to its member firms. Archipelago's business decision to voluntarily comply with the order handling rules extended a powerful additional tool to some traders.

American Century, for instance, realized imputed savings of $9.4 million on $1 billion of listed Archipelago trades in the first half of this year, and more than $220 million in eleven non-traditional venues over 18 months. (American Century owns an indirect equity stake in Archipelago ECN).

Despite the powerful complement offered by Archipelago to ten other non-traditional brokers, some traders express growing frustration at the interplay between ECN orders and the listed equities markets. Those frustrations echo the market maker backing away' charges that dogged Nasdaq market makers prior to imposition of the order handling rules in that market.