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May 10, 2006

A Whole New Ballgame

By Peter Chapman

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In February, ATD Financial Services, the wholesaler division of Automated Trading Desk, received NASD approval to make markets in all Nasdaq and listed securities. From its original roster of 2,500 names, ATD is now able to offer executions to retail broker-dealers in over 8,000 National Market System stocks. The ramp-up is a milestone for ATD, a firm that came out of nowhere in 2002 to become one of the pacesetters of the wholesaling industry. The move also underscores the dramatic transformation of a business remade by regulatory fiat and computer algorithms.

At the beginning of the century, wholesaling was a business conducted by hundreds of clamorous traders on sprawling floors. Today, whirring computer servers produce fine-tuned executions for meticulous order routers.

ATD employs no human traders, executing nearly all trades with computers.

"The wholesale market is very strong, very robust," Chris Nagy, director of trading for TD Ameritrade, one of the largest and most sophisticated order senders, says.

"And new wholesalers are providing a significant amount of competition for our order flow. They share a common trait, in that they are highly automated."

The spoils are increasingly falling to those most automated. "[The ramp-up] has opened up some floodgates for us," Steve Swanson, president and chief executive of ATD, LLC, said.

"Volume has increased. Those firms that wouldn't send us flow before unless we were a market maker are now doing so."

Market Share

As of the fourth quarter of last year, ATD was filling orders for some of Wall Street's largest order senders.

On the listed side, for example, ATD handled 16 percent of Ameritrade's orders (non-directed marketable orders of less than 10,000 shares); 20 percent of Piper Jaffray's; 19 percent of Southwest Securities'; and 7 percent of Morgan Stanley's.

On the Nasdaq side, ATD had 31 percent of BrownCos' orders; 26 percent of Edward Jones'; and two-thirds of RBC Dain Rauscher's.

ATD is one of a handful of wholesalers fighting over retail orders not destined for the nation's primary stock exchanges.

Others are Knight Capital Group, Citadel Execution Services, Bernard L. Madoff Investment Securities, Citigroup, UBS Securities and E*Trade.

They all compete for the order flow of a few hundred larger self-clearing retail brokers and clearing houses.

All of the major wholesalers except for Madoff and Citadel also make markets in over-the-counter names as well. (ATD has just launched its service.) There they compete with a group of smaller, lesser-known wholesalers.

For better or worse, government regulation has transformed the business. Two rules in particular, put into effect in the 2000-2001 time period, have forced players to cut costs, provide better executions and invest heavily in automation.

First, decimalization cut spreads and revenues by reducing the minimum trading increment. Second, Securities and Exchange Commission Rule 605 (formerly Rule 11Ac1-5) forced dealers to publish their execution stats.


Both regs pushed brokers to automate more of their operations, but it is the so-called "Dash-5" stats that have impacted wholesalers' competitive positions.

Rule 605 requires all market makers, not just wholesalers, to make public on a monthly basis certain execution quality statistics.

The metrics were mandated to give order senders some guidance when deciding where to route their non-directed (not held), marketable Nasdaq, NYSE-listed and American Stock Exchange-listed orders of less than 10,000 shares.