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August 23, 2005

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

By Gregory Bresiger

Under the new amendment, conditions of algorithmic price improvement would be changed. Here is one example. Where the quotation spread was three-five cents, the algorithm must provide price improvement of at least two cents.

The previous versions of the Hybrid Plan specified how systems using algorithms could send messages through an API when doing certain tasks, supplement the size of an existing Exchange best bid and offer, layering specialist interest at prices outside the best bid and offer and provide a single-priced execution at the best bid and offer.

But the previous plans didn't detail the specialist's ability to maintain non-displayed or reserve interest at the best bid and offer. The reserve interest will be supplied by the specialist by using the algorithm.

This will "determine an amount of shares that will interact with the order at the same price that is being displayed as the best bid or offer," McSweeney added.

The Exchange's Rule 104 has been amended to say that "specialists may, but are not required to, have non-displayed reserve interest at the best bid and offer," according to the NYSE filing. Specialists must have a minimum amount of interest displayed at the best bid and offer to have a reserve interest in a quote. For specialists, this minimum amount is 2,000 shares.

"This is a positive feature. It will dampen the volatility and the customer will get a better price," according to McSweeney. Indeed, McSweeney said basically the same thing about specialists trading for their own account on parity with floor brokers in the crowd and agency interest files. "We see that," McSweeney said, "as enhancing liquidity at the point of sale, promoting an increase in the size of the displayed bids and offers, which have declined significantly since the introduction of decimals."

Nevertheless, all these changes, critics believe, are designed to protect the Big Board's specialist system, which for generations has given this historic exchange a dominant position in listed business.

But officials of electronic exchanges are expecting to increase their small listed business by large increments because of the new Reg NMS rule. To prevent a loss of listed business, the NYSE's latest hybrid proposal appears designed to protect the Big Board's unique institutions.

"Specialists and Floor brokers will continue to perform their vital functions in the Hybrid Market through the use of floor broker agency files, specialist layered interest files and specialist algorithmic interaction with orders," according to the NYSE filing with the Securities and Exchange Commission.

"The amendment that we have made is the result of broad input."

Robert McSweeney, NYSE

The NYSE decreased the amount of mandated price improvement the specialist must provide when the spread is 11 cents or greater. The NYSE, under the latest amendment, also mandated the specialist provides price improvement when the spreads are 2 cents. Previously, the minimum was 3 cents.

The filing cited several cases of how the new algorithmic policy would work. For example, if the Exchange quotation is 20.10-20.12, and the specialist is represented in both the bid and offer, the algorithm can buy at 20.11 and sell at 20.11.