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December 1, 2003

When The Price Is Right

By John A. Byrne

Institutional investors are paying far too high a price for the New York Stock Exchange specialist system. These specialists do not adequately facilitate block trades. This is hardly a new charge but - hands up - who can quantify the size of the supposed losses to investors from specialists' questionable intervention on trades? One pro has it all figured out. He's Barry Small, CEO at Weeden & Co. where he runs equity trading. Small believes that, if the specialist system was equitable, specialists would lose some 25 percent of their commissions on block transactions. Today, they get to keep this tidy amount. Small, like other pros, takes his calculation from the estimated commissions - about 25 percent - lost' by upstairs block desks facilitating customers. Small does not hesitate to propose immediate reforms. This is what he has to say in welling@weeden, the newsletter published by Traders Magazine contributor Kathryn M. Welling: Transform the specialist into mostly an agent and create two markets out of this change - one for highly liquid stocks, the other for moderately liquid trades. In this scheme, the specialist would only be permitted to act as principal when he is "cleaning up a print," or stabilizing the market. Price improvement would be a distant memory. However, the specialist would charge what Small calls a toll on all stocks he trades - between 1 and 5 mils - a prospect that would motivate him as an agent.

Small then takes a crack at melding a more electronic specialist system with the auction trading. Simply put, limit orders placed by investors would be protected. "If an electronic order is placed in a security against a limit order, that trade must take place at that price," Small writes. "Auction market players would split that trade with the limit order. No one could price improve on an electronic order of a certain minimum size, say, 1,000 shares. The electronic order gets immediate execution, the limit order is rewarded, the auction market not-held order participates, the specialist collects a toll charge." Small notes that his proposed system would require an overhaul of the Intermarket Trading System. He's one of countless voices sounding similar warning cries for the NYSE. Of course, some of these outbursts are pure theatrics, stage managed to hurt the Big Board at a time when it is vulnerable. Still, much of the criticism is well documented. And what about the trade through rule? It's starting to sound like a rule imposed by some deranged old codgers running major league baseball. But the rule is hurting. And it might all change. The NYSE is floating some plans for reform. One early idea was an ETF-like de minimis exemption, perhaps of two cents, on small orders restricted to market centers with low fill rates. That won't fly, the SEC's Annette Nazarette recently told Traders Magazine. The only member of the ITS group that supported it robustly - unsurprisingly - was the NYSE itself. But Traders Magazine will keep you informed as this financial drama unfolds. In the meantime, for more on another Weeden pro's outlook, please turn to Kathryn M. Welling's profile in this issue with Weeden's own iconoclast, Don Weeden.

Have a peaceful holiday.

John A. Byrne