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August 23, 2005

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

By Gregory Bresiger

"We are no longer for it. The first four amendments were offering limit order protection to the people who display orders," said John Wheeler, Vice President and Director of U.S. Equity Trading at American Century Investments. He contended that the NYSE, after hearing comments from the specialists committee about the first four amendments, "watered down the plan and added a lot of confusing language."

The Investment Company Institute (ICI), a fund industry trade group, has also sent a letter to the Securities and Exchange Commission opposing the Fifth Amendment. It listed many of the same objections. (See At Deadline).

In essence, these proposed changes in the latest amendment mean that the NYSE is submitting a new plan that updates the role of the specialist. The specialist will continue to view all incoming orders before the public does, but with "specific limitations."

Indeed, NYSE competitors have long argued that specialists are granted unwarranted advantages. However, NYSE officials said that the ultimate goal of the Fifth Amendment is to "balance the goals of preserving incentives for the limit orders on the Display Book to establish best price and of encouraging price improvement for incoming orders," according to the filing.

"Without it (limit order protection), people will be making decisions in an information vacuum."

John Wheeler, American Century Investments

"The balance is in the manner in which we restrict the specialist algorithm as to how it interacts with incoming liquidity," Robert McSweeney, Senior Vice President of the NYSE's Competitive Position Group, told Traders Magazine.

"The restrictions provide a narrower range of opportunities than the conventional auction. It has limitations," he added. "These include that, if an order comes in between the bid and offer, a specialist cannot interact with that order until it is publicly disseminated in the market data," according to McSweeney. But Wheeler countered that the latest amendment is weakening the limit order protection of previous amendments. The first four amendments protected, "the people who display the order," according to Wheeler. He said it was an integral part of the price discovery process.

"Without it," Wheeler added, "people will be making decisions in an information vacuum."

Still, McSweeney argued the changes will benefit all market participants. And he insisted that the restrictions of the Fifth Amendment imposed on the specialist, "the same responsibilities that we require of a dealer. They commit him to supply stabilizing capital, which will dampen volatility and improve prices for investors who are representing orders in our marketplace," according to McSweeney.

He said this latest hybrid market version will provide the specialist with the ability to "sweep liquidity" at the best bid and offer. He added that floor brokers, not just specialists, will also have access to many of these features. "The floor brokers, using their hand-held-computers, and using a discretionary order type, will also have the ability to interact between the quote and the order," McSweeney explained.

The Fifth Amendment clarifies and helps the specialist to provide algorithmic price improvement. Indeed, it expands the parameters for price improvement included in previous amendments.