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November 29, 2005

At Deadline

By Editorial Staff

FIDO Drops First Shoe

*Fidelity Investments' decision to pay Lehman Brothers from its own pocket is bad news for most of the equity trading industry, according to a report.

"It will likely force consolidation of both the buy-side and the sell-side," according to a Morgan Stanley report, entitled "Fido Sneezes. Who Catches Cold?" The report comes in the wake of reports that Fidelity will use its customers' commissions to pay only for executions at Lehman while using most of its own money to pay for research.

If the rest of the trading industry follows the lead of Fidelity and Lehman, there will be "pain" throughout the industry, the report predicted. Morgan Stanley believes Fido has allocated $7 million for its research agreement with Lehman. Asset managers and equity trading desks will have lower margins, the report said. It also expects a 25 percent drop in the revenues paid by the buyside to the sellside for services in U.S. equities. This would force brokers to do more principal trading than agency business. More industry consolidation would follow. Who wins? The report says those firms with multiple revenue sources outside of the pure cash business will be winners.

Less Crowd, Less Info

*The life of the independent floor broker at the New York Stock Exchange will be more difficult once the exchange converts to a hybrid market, according to Bob McCooey, chief executive officer of Griswold Company, one of the larger independents.

"With hybrid," McCooey told the audience at the Security Traders Association's annual conference last month, "we will have to predetermine our interest to trade at a certain price. We don't have to do that right now."

Now, when he has an order, McCooey explained, he is able to trade it based on information he gets from being in the crowd. Under hybrid, much of the trading may take place on the specialist's book and away from the crowd. With fewer orders flowing into the post, there could be less information available to the floor broker upon which to base his decisions.

Therefore, McCooey said, a floor broker will have to represent his orders on the specialist's book through the use of reserve files and hidden limit orders. And pricing those orders will be challenging without the benefit of a centralized trading crowd.

Hybrid Timetable

*The NYSE announced a timetable for its transformation into a hybrid marketplace, combining open outcry with electronic trading. Bob McSweeney, who heads New York's competitive position, made the announcement at the recent STA annual meeting in Boca Raton.

The transition is to occur in stages so members can acclimate to the new trading environment. To start, the New York will add e-quote functionality to floor brokers' handhelds. The e-quote software will allow brokers to add layers of trading interest in the specialist's book. Then, in the first quarter of next year, the NYSE will introduce the specialist algorithms. These computer programs enable specialists to trade against orders hitting their electronic books. In April or May, the New York will begin to lift the restrictions on Direct+ that limit order size and frequency of use. Finally, by the end of June, concurrent with the introduction of the SEC's new trade-through rule, the New York will finish certain workstation productivity enhancements.