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August 23, 2005

Latest NYSE Hybrid Plan Helps Specialists; Amendment Spawns Chorus of Critics

By Gregory Bresiger

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(Traders Magazine, August 2005) -- Help the individual investor. Help the specialist. Which is it?

That's the issue raised by the NYSE's latest hybrid plan, a plan that is creating more controversy in the trading industry than the previous four hybrid plan amendments.

That's because specialists are the beneficiaries of the latest version of the New York Stock Exchange's hybrid market plan, critics charge. However, NYSE officials dismiss this critical interpretation of the latest 200-page plan, which began as a 20-page document when it was originally presented last summer. Instead, they contend the plan is mainly designed to make the Big Board more efficient.

This will happen, they say, by continuing to give specialists a first look at all incoming orders but with new limitations on how they go about finding liquidity. These limitations detail how the specialist can use the Display Book.

The plan, now in its Fifth Amendment, updates the Big Board's electronic execution system, Direct+, while preserving the exchange's manual auction and specialist system.

Some of the proposed changes in the latest amendment include: Allowing the specialist to post hidden reserve; and ending restrictions against specialists trading for their own accounts on parity with floor brokers in the crowd and agency interest files.

The plan also details the ways that specialists would have greater opportunities to employ algorithms. It permits a specialist to use one instead of two algorithms. This is a change, an NYSE official said, "that makes more sense technologically; it allows the application to interact with one data stream."

Specialists, under the new plan, also would no longer be required to trade an entire order when "supplying additional volume." Before this amendment, the specialist had been charged with executing against all remaining trading volume. Now, he will be permitted to trade only the portion of an order that he wants.

The Fifth Amendment also facilitates specialist price improvement.

Under Amendment No. 5, the NYSE has eased the ways by which the specialist may price improve. In previous versions, for instance, the specialist could not trade against any incoming orders by improving upon the NYSE's best quote if the spread was only 2 cents. Now he would be able to do so. This could lead to complaints by traders posting limit orders, contending that the NYSE has made it easier for specialists to "penny," or step in front of, their orders.

Previously, the smallest spread under which the specialist could price improve was 3 cents. Also, in contrast to previous hybrid plan versions, now the specialist doesn't have to be represented in the exchange's best quotes by any "meaningful amount" to price improve. He must still be represented in the quote, but in any amount he chooses.

The changes have drawn the fire of critics. Some agree that the first four versions of the hybrid plan were fair, but that this latest version has been tilted in favor of Big Board intermediaries, critics charge.