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September 22, 2005

PHLX Gains New Life

By Michael Scotti

There's new life at 1900 Market Street in the City of Brotherly Love. An equity infusion into the Philadelphia Stock Exchange by six major brokerage firms could make this once downtrodden regional exchange a more popular venue for equities and options.

One source familiar with the investment said that PHLX has a market share in options that could skyrocket to 30 percent, given the ability of its investors to provide order flow.

Currently PHLX has a 10-percent options market share. Although many industry observers say the investment is primarily about options, one knowledgeable broker said the investment could be as much an equity play as one on options. "It's an equity hedge," the broker said, adding that it lessens the leverage that either the New York Stock Exchange/Arca or Nasdaq/INET would have from raising trading fees.

It was trade-through protection, promulgated by Reg NMS, that gave the regional stock exchanges new importance. Now, when the PHLX has the best price in the National Market System, that quote will have priority over all others in the NMS.

There's optimism on the floor for both equities and options. "Now we see a future," commented one trader on the floor of the PHLX. "Before we weren't so sure there'd even be a place for us with all the consolidation."

The investing brokerage firms collectively now own 45 percent of the PHLX, with an option to purchase additional ownership, according to a knowledgeable source. Merrill Lynch, Citadel Derivatives Group and now Morgan Stanley, each paid $7.5 million for 10 percent of the PHLX. Citigroup, Credit Suisse First Boston and UBS each paid $3.75 million for 5 percent. Each partner has the option to double its ownership if it delivers a certain level of order flow to the exchange, the source added. The amount of order flow sent to the PHLX will also dictate how much each broker pays to exercise its option to double its ownership. The PHLX demutualized about two years ago and is owned by 505 shareholders.

Al Perry, managing partner, McNamara Trading, the largest $2 broker on the PHLX floor, said he's optimistic that firms like his can carve out a niche and earn its share of business. "We're not here to replace the NYSE," he said, "but we spent our money on technology when other regionals weren't."

But bringing in new investors didn't please all shareholders, Perry said. That's because their ownership could drop to about a 10 percent stake if all the brokerage firms exercise their options, he said. "They feel their ownership is being diluted. But would you rather own 10 percent of something big or 100 percent of nothing?" asked Perry. "I think we're moving in a very positive direction."