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February 1, 2002

An ATS Enters Specialist Game: A Link to Cincinnati and the ITS

By Peter Chapman

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  • An ATS Enters Specialist Game: A Link to Cincinnati and the ITS
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Traders who want to act as their own specialists now have their chance.

An alternative trading system called Elephant eXpress is making it possible for traders to access the National Market System (NMS) via a link with the limit order book of the all-electronic Cincinnati Stock Exchange. Traders can post their own quotes in the Consolidated Quotation System and trade directly with bona fide specialists and third market dealers over the Intermarket Trading System.

A group of hedge funds and day traders has been using the system for the past year.

Traders no longer need to delegate the handling of their orders to an individual who may not have their best interests at heart, says co-creator David Sher.

"We give our customers the ability to interact with the market as if they were specialists," said Sher, president of ElephantX dotcom, the small New York-based agency brokerage which owns the ATS. "Changing, updating or canceling orders is instantaneous."

The ATS is the brainchild of David and his twin brother Robert Sher, both ex-hedge fund managers themselves. Age 38, the brothers founded ElephantX in May 1999, after running Lafayette Capital Management from 1997 to 2000. Their largest single investor is Bear Stearns, formerly Lafayette Capital's prime broker and, once David Sher's employer.

The big broker also supplies about half of ElephantX's institutional client base from the ranks of Bear Stearn's clearing customers. The customers access the service through Bear Trade, Bear Stearns' proprietary order routing network.

In total, ElephantX's institutional customers number nearly 100. Most are basket-trading hedge funds, although the brothers count four of the top program traders on the New York Stock Exchange as customers.

Day traders are also signing up and the firm is actively pursuing deals with such direct access organizations as Track Data and Neovest.

Fast on the draw, such traders like the fact that they can cancel their orders instantly and auto-ex against other CSE specialists.

Here's how it works: An order placed on the system is eligible for execution against other orders in the ATS. If the order also happens to be the best quote in the ATS, it becomes the best quote on the limit order book. The order then becomes executable by all specialists at the Cincinnati. If the order represents the best quote at the Cincinnati, it becomes the Cincinnati's quote in the CQS. It then becomes executable by all specialists and third market dealers in the country over the ITS.

Traders can use Elephant eXpress to take out the quotations of other specialists over the ITS, but few want to, according to Sher.

Problems Solved

Sher says the service solves two problems. First, traders can be certain their best-of-market orders will be reflected in the national quote immediately. Often, he says, a specialist will delay posting a customer's order. Or, he will simply update his own quote rather than post the better-priced order. He might improve the price by a penny, but, in either case, the customer's order is not displayed.