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December 1, 2004

Saving The Little Guy

By John A. Byrne

The institutional investor needs the same sort of regulatory protection as the Little Guy. In a perfect world, both sides of the financial markets would work it all out. But it is an imperfect world and it is impossible to fix all the imperfections of human nature. Morality on Wall Street, therefore, must be regulated. Unfortunately, the Little Guy seems to be getting too much of the attention. Don't get me wrong: The little guys, especially the poor and the politically weak, deserve a preferential option. However, the scales have now been tipped too far in the financial markets. The institutional investor - and the huge and sometimes impersonal brokerage behemoths - are far too often viewed by regulators as the Great Satan. It is a shocking kind of logic. Sure, there are many disturbing signals from these financial giants. But that's a separate matter. In recent weeks, the crisis in U.S. market structure has deepened. It is a crisis because the broker as an agent in the trading markets is disappearing. The agent has been replaced by - get this - these very same brokerage behemoths who understand the meaning of go with the flow.

Now a wee bit of history: Block trading - finding the "natural" - never made much money for traditional sellside desks. But it was a way to generate real money from other business. Today, however, the typical buyside desk - except for the largest investors who can push the sellside around - no longer cling to these upstairs arrangements. It seems that both sides of the Street are now more like pale imitations of each other. This is weird. Transaction costs have plummeted along with the margins of dealers and specialists. The seven specialists on the NYSE, for instance, lost a total of about $11 million in the first quarter of 2004. That's down from a profit of $195 million in the same quarter the previous year. If you work on the sellside, the game has become this: Attract as much order flow as your pipelines and resources permit. Become big and brave. Use all the information and order flow to make your own trades. Jason Trennert, an analyst at ISI Group in New York, has studied the trends and is worried. "The dual role of brokers as both principals and agents, and the reduced role of the institutional salesman, are reinforcing the notion that shares of stock are merely trading vehicles than actual ownership of a business," he recently wrote. Trennert repeated a rumor making the rounds: One major sellside firm recently "fired" some of its major mutual fund clients. It ended all attempts at providing research. It demanded to do business exclusively on a net basis. It is appropriate that the Cover Story shines a trading light on the mushrooming world of hedge funds. The growth, in some respects, is emblematic of the market structure changes that are causing chaos. Despite all the best regulatory protection, despite the multiple reforms, the Little Guy gets hosed. Seems like the Little Guy might have a lot to be worried about.

Happy Holidays!

John A. Byrne