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January 1, 2007

Reg NMS Spawns New Order Management Player

A Vendor Pinch-Hits for Exchanges

By Peter Chapman

Also in this article

The restructuring of the nation's regional stock exchanges spells opportunity for one vendor. Selero, a Denver-based connectivity provider, hopes to take over the role some regionals once played in supplying trading technology to their broker-dealer members. Regionals such as the National, Boston and Chicago stock exchanges once provided their members with order management and trade execution systems, but have since abandoned those platforms as they reinvent themselves under Regulation NMS. Selero hopes to fill that void. Last summer, the vendor

formerly known as IBSN bought CATS-for Client Automated Trading System-from the National Stock Exchange.

The technology was used by certain NSX members to make markets as specialists on the NSX. Most were retail brokers who signed on as specialists to internalize their small orders.

Selero has rebranded CATS as the Selero Trade Execution System (STX) and plans to offer it to former regional stock exchange specialists and any other broker-dealers that need such a system. It is offering the system to broker-dealers on a hosted (ASP) or license basis.

"There are several broker-dealers doing this in some capacity," noted Michael Wojcik, a Selero vice president and NSX employee for 15 years. "They won't have an exchange offering to do this."

Nevertheless, Selero is not without competition. Its "trade execution system" shares similarities with sellside order management systems such as Fusion by NYFIX and Brass by SunGard. And NYFIX, at least, is also gearing up to service market makers in a post-Reg NMS world.

Lined Up

Selero's initial target is a group of 25 to 50 broker-dealers that "might do business on any one of the exchanges," according to Wojcik. The company already has a "handful" of customers for the product, according to Wojcik's colleague Diana Lawrence.

Internalization occurs when a broker-dealer takes the other side of an incoming customer order in an exchange-listed security.

The firm will buy from its selling customers and sell to its buying customers and take the position onto its books. It will not send the order to an exchange. This saves the broker-dealer from paying exchange fees.

Many large retail brokers, though, especially the discounters, found a way to hold onto their own orders but still send them to an exchange.

By establishing regional exchange specialist operations they could internalize, but also give their customers the highly valued "exchange print." Charles Schwab, Fidelity, E*Trade and Scottrade all operated regional specialists at one time or another.

With the coming of Reg NMS and its centerpiece trade-through rule, regional exchanges have gained new clout and their roles as internalization facilities appear to be in jeopardy.

Deciding to compete head-on with the New York Stock Exchange, regionals revamped their business models along the lines of ECNs.

They built fast electronic matching engines and adopted rules guaranteeing price-and-time priority to all comers. At the same time, they dismantled their specialist systems and jettisoned their trading systems. The Chicago mothballed MAX; the Boston did the same with Beacon.

For now, anyway, they have shied away from granting special order-handling privileges to market makers.


Internalization, though, is far from dead, thanks to the trading reporting facilities (TRFs). The Securities and Exchange Commission's approval of hotly debated trade TRFs, which broker-dealers report their internalized trades, is expected to make internalization a significant part of the exchange landscape.