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September 22, 2005

Vanguard & NYSE Advisory Group Question the Big Board's Latest Hybrid Proposal

By Gregory Bresiger

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  • Vanguard & NYSE Advisory Group Question the Big Board's Latest Hybrid Proposal

The Vanguard Group is the latest critic of the fifth amendment of the New York Stock Exchange's hybrid market plan, a plan that may be recast after an NYSE advisory committee of buyside traders recently raised objections.

Meanwhile, Vanguard officials complain that the way specialists would be able to use algorithms under the fifth amendment is "unfair" to other market participants, who would be forced to use specialists without cause.

"The specialist algorithms will have access to several types of data, including information about orders on the Display Book (such as limit orders) as well as incoming orders as they enter the Exchange's systems," according to a Vanguard comment letter.

The NYSE hybrid plan is an attempt to meet the demands of regulators and customers, but simultaneously provide for the needs of specialist member firms. Some of the latter are facing declining profit margins. The first four amendments didn't create the controversy of the latest plan. Critics charge the NYSE decided, in the fifth amendment, to restore advantages of the specialists, who supposedly had complained after the first four amendments.

Specialists, under the plan, would have 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 updates the Big Board's electronic execution system, Direct+, while preserving the exchange's manual auction and specialist system.

Some other debated changes in the latest amendment include: Allowing the specialist to post hidden limit order reserves, ending restrictions against specialists trading for their own accounts on parity with floor brokers in the crowd and agency interest files, all of which, critics contend are requiring orders to go through specialists unnecessarily.

"The plan puts us at a disadvantage. We must place a reserve order through a floor broker. Why can't we just do it ourselves?" asked Gus Sauter, a managing director with the Vanguard Group, in an interview with Traders Magazine.

"We are concerned that the ability of specialists to access information before other market participants and price improve limit orders provides them with the equivalent of a hidden limit order," according to the Vanguard letter. Sauter said a better market structure than the latest hybrid proposal would contain fewer specialists and smaller transaction costs. Market observers share Sauter's concerns but are more restrained.

Specialists have always had various advantages, noted Jamie Selway, an executive with White Cap Trading. The hybrid just formalizes them, he said.

"They've been pretty clear in these five amendments about the advantages that the specialists are going to have. You may not like what you see, but you have to give the New York Stock Exchange some credit for honesty," according to Selway. Nevertheless, he said that the plan "is not good market structure" because it gives too many advantages to specialists. Selway prefers the Nasdaq model because it offers "a confederation of choices."