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September 22, 2005

A Familiar Road

By Michael Scotti

It seems we've been down this road before. The investment by six brokerage firms into the Philadelphia Stock Exchange is reminiscent of what happened after the SEC's Order-Handling Rules were implemented in 1997. If you recall, the handling rules required market makers and specialists to display customer limit orders that equaled or bettered their current quote.

Nasdaq market makers, at the time, had no place to post their quotes, so Instinet became the market makers' ECN of choice. Why? It was the only game in town. So market makers, weary of writing checks to Instinet, formed their own ECNs. And if memory serves, the number of ECNs later topped out at nine. Today, the last of the old-guard ECNs have found merger partners: INET to Nasdaq and Archipelago to the NYSE.

Fearing to some degree that Nasdaq and the New York could be the only games in town like Instinet in 1997-Merrill, Citadel, Morgan Stanley, UBS, CSFB and Citigroup ponied up $33.75 million to buy 45 percent of the PHLX. That investment could grow. In fact, yet another new mart-the all-electronic Boston Equities Exchange (BeX)-backed by Lehman Brothers, CSFB, Citigroup and Fidelity Investments, was announced today.

Sure, it's a bet that they hope will pay off like Goldman Sachs' investment in Archipelago. And it does offer the possibility that brokerages could send order flow to either Philly or BeX, which could make either one a viable marketplace for equities. The investments also serve as a lever on the NYSE and Nasdaq-the so-called "duopolists"-to keep transaction fees in line. It might be fair to say that Wall Street's new mantra of "smarter, faster, cheaper" will dictate which exchanges receive the order flow.

In this month's cover story, incoming STA Chairman Bill Yancey points out how increased electronic trading intelligence allows for the largest stocks to trade in the same way, whether they are listed on Nasdaq or the NYSE. Within five years, Yancey continues, it will be "difficult to distinguish listed and Nasdaq markets when it comes to quoting and execution efficiency."

The NYSE's hybrid market model is what may actually separate the two main markets. Many believe a successful hybrid will dictate how the secondary stocks will trade, as well as special situations that might require a crowd. Without a successful hybrid market model, it would be fair to say that there would be little difference between the NYSE and Nasdaq. It might then be a matter of time before the industry, striving for greater efficiency, asks itself: Why do we support two exchanges? NYSE Chairman John Thain-as reported by Gregory Bresiger in his Washington Watch story-was in discussions to put back into place some more of the demands from the institutional client base of the exchange regarding the latest hybrid market proposal. This responsiveness is an acknowledgement by the NYSE that it has to be customer-centric.

Michael Scotti

Editorial Director