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April 1, 2004

Number Crunching at the NYSE: The NYSE's franchise could bein danger if a new regulatory proposal i

By Peter Chapman

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The days of Big Board dominance of listed trading are over. At least

that's what some proponents of electronic trading are hoping after reviewing the Securities and Exchange Commission's latest market structure proposal. At the heart of the document is a trade through plan that legitimizes the practice of trading through the best quotes. The SEC plan, if approved as currently outlined, would propel the listed markets towards more fuller automation, and give traders wide latitude to ignore quotes whose firmness' they doubt.

This sea change in the controversial trade through rule is viewed as a potential triumph for NYSE competitors. "This is a strong step forward," said Andrew Goldman, an executive vice president at Instinet, which operates INET, the nation's largest ECN. "It is an interesting proposal that also shows much promise by allowing investors to opt out of the trade through rule."

Market Share

At stake is the Big Board's 80 percent market share in the trading volume in NYSE listed securities. The reform of the trade through rule would likely reduce the Big Board's dominant share, according to many observers. Besides Instinet, other players which could pick up listed volume include the Archipelago Exchange, Nasdaq's SuperMontage and the Brut ECN.

At the same time, there is support for the proposal from other quarters of the institutional landscape. CalPERS, the nation's biggest pension fund, which recently sued the Big Board, voted to support the SEC plan. "I commend CalPERS for supporting much-needed reforms to the outdated trade-through rule," California State Treasurer and CalPERS board member Steve Westly said in a statement.

The SEC's proposal is part of a comprehensive package of market structure reforms known as Reg NMS. These come in response to perceived flaws in the National Market System.

The trade-through rule would be applied to Nasdaq as well as listed securities, and would likely supplant the current ITS Trade-Through rule that governs the listed market. The ITS rule prevents market centers from facilitating trades at prices inferior to those found elsewhere. And 93 percent of the time, the highest bids and lowest offers are reportedly on the Big Board.

Many traders, especially those using electronic venues, would like to be permitted to trade through the NYSE quote. The relative slowness of the Big Board's manual order handling procedures makes it difficult to access its quotes in a timely manner, these traders complain. On an electronic system, access is less problematic.

The electronic marts have waged a four-year battle to repeal the ITS Trade-Through rule. They say it props up an anachronistic New York Stock Exchange by preventing customers from trading through its quotes on their systems.

The Big Board strongly defends the trade-through rule. It maintains that traders taking the initiative to set the market should not be bypassed.

However, in its proposal, the SEC clearly sides with the electronic players. "Modifying the existing listed market trade-through intended to assist those institutions that seek direct and efficient interaction with contra trading interest," the regulator states in Reg NMS.

The ECNs