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May 31, 2004

Trade Throughs for Simpletons?

By Nina Mehta

How time have changed. Not so long ago, buysider traders did not enjoy today's interaction with orders.

"The biggest change for traders is that we are continuing to take more control of our orders," said Paula Peter, manager of equity trading at Pittsburgh-based Mellon Private Wealth Management, which has some $76 billion under management.

Peter should know. When she was profiled several years ago for this column, that level of control did not typically exist.

"We are very active in determining how and where our orders are executed, and we are far less dependent on the Street than we were in the past," Peter added.

This translates into more technology on the trading desk. Mellon Private Wealth Management utilizes traditional brokers, several ECNs, and crossing systems like Liquidnet. The firm also uses electronic tools that enable traders to slice orders into the market, or peg orders to the market in order to keep up with fast-changing quotations.

One reason for this emphasis on technology is the development of ECNs and other electronic marketplaces. Another is the rise of transaction cost analysis systems, which enable traders to measure the quality of their executions.

But a third reason stems from the concern that "traditional sellside firms are becoming more aggressive in their proprietary trading and may be shooting against orders," Peter says. That concern leads traders to opt for electronic systems that preserve anonymity and reduce market-impact costs.

For the sellside, the consequences of this are beginning to take shape. Peter notes that research analysts at her firm are increasingly interested in boutique research shops. These are regarded as having fewer inherent conflicts with investment banking or proprietary trading desks.

"We are paying commissions to firms that we'd never heard of a couple years ago, that have recently sprung up and have a niche in the marketplace," Peter says. "They're not all sheep with the same investment recommendation."

About the SEC's proposed Regulation NMS, Peter hopes that competition and freedom are not hindered if a new framework is adopted. She's also critical of the delay in reporting trades on ITS, the intermarket trading system. She adds that the system, "needs to be enhanced, upgraded or scrapped."

Peter also points out that the definition of an automated market should require automated execution on the entire limit-order book, not just the best bid or offer.

On the trade-through rule, Peter believes it's been oversimplified into a price vs. speed debate. Indeed, she wonders whether a price that can be obtained quickly is necessarily the best price. "I may have an opportunity on the floor in an auction market to get a better price if I'm willing to have my broker open up," Peter says. The reluctance of traders to show their hand likely makes sense. Her point is that these decisions have ramifications for price discovery.

"We may be missing opportunities to put up large blocks on the floor of the New York Stock Exchange because we're concerned about transparency or specialists," she says. "So we're turning to systems where we can trade in small amounts. But we may be getting duped into thinking that speed is getting us the best price."

Peter acknowledges that criticism of specialist firms has grown. However, the regulatory scrutiny and fallout from scandals will force change, she says. Peter, nevertheless, believes the specialist system adds value.