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March 1, 2002

One Moment in Time

By John A. Byrne Editor

New classes of professional traders and market centers are emerging from the swamplands of our current U.S. market structure. It looks exactly like a plateful of spaghetti in a representative diagram, which is part of a new report published by Lehman Brothers' analysts Maureen Murphy and Luba Krayterman. At first, an examination of this structure should beg the obvious question: Why does it all have to be so needlessly complicated? The reason may have more to do with fear and greed, than with rhyme, reason and common sense.

From destination ECNs to their hybrid relatives - as well as alternative trading systems that offer crossing and others that provide buyside to buyside bargaining sessions - the entire process has run amok. It has run amok in the swamplands of market fragmentation and price and size discovery nightmares. That is not the conclusion of the Lehman report, but it is a conclusion that the report would seem to support.

It is possible there is a redeeming value in this madness, but it is hard to detect. (These and other issues are explored in this month's Cover Story by Gregory Bresiger, Nasdaq Under ECN Attack, and in an examination of our markets by former brokerage industry analyst Jim Marks. Another analyst, Greg Smith, and a buyside trader, Brian Pears, are noteworthy market observers who contribute regularly to our Website,

The Lehman report makes some valuable points. As if reading our mind, it says that the Big Board is far from doomed. In part that is because of brand strength, in part it is due to its political power - check the campaign contribution list (our suggestion) - and in part it is due to native cunning. ECNs that will do battle with the NYSE must be ready for a formidable foe. Small trade executions, the traditional strength of ECNs, are free on the NYSE, the Lehman report notes. On the other hand, as Island demonstrates, "Its penetration of the QQQ market, one of the most actively traded securities in the world, has challenged the notion that a traditional exchanges' market share cannot be eroded," the Lehman analysts state.

Then there is Nasdaq. As fragmentation increased in the OTC market, the SEC stepped in to restore more power to Nasdaq, approving the "quote-aggregating" SuperMontage. "SuperMontage can be successful in reaggregating liquidity if it makes trading at ECNs not worth the effort. However, the fact that participating is voluntary may be the loophole that allows destination ECNs to survive," the analysts note.

"For ECNs to succeed, they will have to collaborate to provide a more seamless reaggregating solution," the report adds. "Individually they will only fragment the market further, but together they will be a formidable threat. Liquidity will decide the winner of each battle, though the war will be far from over."

In sum, a fascinating account of one moment in time - taken, of course, from the swamplands of market structure in the U.S. in 2002.

John A. Byrne