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August 23, 2005

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

By Gregory Bresiger

"The Exchange believes the benefit of providing meaningful price improvement to incoming orders under such circumstances would outweigh the potential disincentives to post aggressive limit orders," according to the Fifth Amendment.

Critics have charged that the NYSE through its hybrid plan is attempting to save the specialist system under the guise of modernizing the Big Board (See Traders, Washington Watch, July). The latest NYSE hybrid plan was also criticized by a trading industry official, who didn't want to be quoted by name. He said that the Fifth Amendment was "shortsighted," giving too many advantages to specialists.

"This system has to be fair for everyone in the market, which it isn't now. Otherwise, specialists will have an issue somewhere down the line and they'll have a black eye again," the official told Traders Magazine.

This trading official also complained that specialists, under the latest version would know, "before anyone else that a program just hit the floor and what side it's on and maybe what the impact is. The specialist will be able to generate orders electronically to other markets; to clear out those markets," the trading official said.

"That will likely give the specialist an informational flow advantage that the specialist will have at the point of sale that nobody else will have," the trading official said.

The plan is due to begin in the third quarter and have a full rollout by the end of second quarter of 2006. NYSE officials have contended that the plan gives specialists the incentive to modernize operations, which will lessen volatility and increase liquidity.

That's because specialists, NYSE officials have said in various filings, will commit capital and provide market depth in response to the competition for orders among floor brokers. Revising the specialist/floor broker system, NYSE officials believe, will lead to more orderly markets and a better deal for the retail investor.

Others disagree. They believe that, as the NYSE becomes a faster, more electronic market, that it will also become more volatile and that average order size will decline. Under those circumstances, specialists would probably have difficulty competing effectively. This latest amendment was the result of specialist complaints, critics say.

"That view is not accurate," said the NYSE's McSweeney. "The amendment that we have made has been the result of broad input and was done with a focus on the investor, not the market participants. So our objective is to provide investors with the broadest amount of choice and in an environment in which they can execute their orders at the best possible price."

Still, the trading industry official said, the hybrid plan is partly a result of complaints to NYSE leadership by specialists who are facing declining margins.

Wheeler, critical of the Fifth Amendment, nevertheless said that its effect may not dramatically help NYSE specialists. "Reg NMS will probably level the field with the exchanges," he said. "Regionals," Wheeler predicted, "under Reg NMS, are likely to become more and more competitive. Market participants are going to have more options, especially if NYSE leaves Archipelago alone."