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July 5, 2006

NSX Bangs For-Profit Drum and Expects New Offerings

By Peter Chapman

The National Stock Exchange (NSX), in what is now a firmly established trend, expects to be the latest exchange to demutualize and reconstitute itself as a for-profit entity.

The exchange's members, of which the Chicago Board Options Exchange is the largest, voted in January to demutualize. The National hopes to go private sometime this month, pending Securities and Exchange Commission approval.

"This will help us run a more business-like business," David Colker, the National's chief executive told Traders Magazine. "It will allow us to raise capital and build a new state-of-the-art trading system."

The move by the National to go for-profit is the latest by a U.S. exchange. All of the country's stock and derivatives exchanges are in some stage of demutualization. Some have already issued stock.

The National is owned by its 43 broker-dealer members and the CBOE. As of December 2004, the CBOE controlled about 62 percent of the National's equity, according to its annual report, through special membership certificates.

Last May, however, the NSX bought back half of the CBOE's certificates, Colker says, and the CBOE relinquished three of its six board seats. The NSX is in the midst of a four-year agreement to buy out the CBOE.

The National is in talks with various potential investors and expects to make an announcement soon, Colker said. Funds will be used to, among other things, replace its decades old NSTS trading system. Colker says a new internally built trading system should be on line this summer.

As part of its restructuring, the National will make at least one significant change to its rule set when it jettisons its trademark preferencing rule.

The rule makes it possible for order senders to direct orders to specific specialists without fear of interception by other specialists. In the past, this made the NSX popular with retail brokers seeking to internalize their NYSE-listed flow. They merely directed the flow to their own specialist units.

Internalization will still be possible at the National, according to Colker, even without the preferencing rule. The National plans to establish a so-called Trade Reporting Facility (TRF) with the NASD, Colker says.

That will allow certain NSX members to report their internalized trades to the joint NASD/National TRF. Most of the reporting fee revenue will accrue to the NSX.

"Like everyone else, we are combining a strict price-time model with a TRF model for internalization," Colker said. "The matching engine will be strictly price/time."

The exchange currently has five specialist members, down from 12 in 2000. They are Bernard L. Madoff Investment Securities, Credit Suisse, Swiss American Securities, a unit of Credit Suisse, E*Trade and Scottrade.

Both Madoff and Credit Suisse hold board seats.

Whether the new internalization set-up will deter broker-dealers from internalizing at the National is uncertain.

Executives at Madoff, for one, declined to comment.

The National's fortunes took a turn for the worse last year when Nasdaq bought INET. The large ECN was an NSX member and provided it with significant trade reporting revenues.

Reported volume has plummeted since the deal.

In May 2005, for example, the National took credit for an average 425 million Nasdaq shares per day. In April 2006, it reported about 1.5 million.

The National is clearly hoping its new structure as well as broader market changes Reg NMS and exchange consolidation in particular will allow it to prosper.

"This new opportunity will allow us to create a whole new business," Colker says, "and replace the lost INET business."

The exec says the exchange, which has 60 employees, grossed between $55 million and $60 million in 2005.

The CBOE reported the National grossed approximately $20 million in each of 2003 and 2004.