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December 19, 2007

2007 Review: NYSE Broadsided by Reg NMS

The Year in Trading

By Peter Chapman

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This was not a good year for the New York Stock Exchange.

The venerable marketplace got slammed by a rule change pushed through by a federal government determined to modernize the U.S stock market. The move stripped the New York of its protective covering, forcing the largely manual marketplace to compete in an unfamiliar electronic world.

The Securities and Exchange Commission's Regulation NMS trade-through rule gave traders the go-ahead to ignore quotes on the Big Board if they were not automatically accessible. That forced the New York to fully open its display book to automatic executions, rendering the Big Board little different from any of the dozen other electronic marketplaces.

Its new status as one more electronic marketplace has done nothing good for its market share. From 66 percent in January, the Big Board is now only doing about 40 percent of the volume in its listed shares.

The exchange's new electronic profile is best illustrated by statistics published by the NYSE. In the third quarter of last year, about 28 percent of all trades were executed automatically. In the second quarter of this year, between 82 and 84 percent were.

The big leap into electronic trading has left the denizens of the NYSE's floor, the heart of the "old" exchange, in disarray. Many are gone. Those who remain are trying to adapt. Some are thriving. Many are not. The once-vaunted specialist has been hit hardest. Once the central player in the floor's auction process, the specialist has been sidelined by the migration of trading to other marketplaces. Two specialist firms abandoned their posts this year, giving up their stocks.

Van Der Moolen Specialists, which handled about 400 stocks, and SIG Specialists, a unit of Susquehanna International Group, with about 150 stocks, quit the business. In last year's third quarter, specialists participated in anywhere between 5.5 and 6.8 percent of all trades, depending on the activity level of the stock. In this year's second quarter, specialists are involved in between 2.5 and 3.5 percent of all trades.

That decrease may be behind the decline in the quality of quotes at the Big Board. In last year's third quarter, among the most active stocks, the NYSE set the national best bid or offer two-thirds of the time. In the second quarter of this year, that number declined to 55 percent. The change was similar among less frequently traded securities as well.

Price improvement is down on the NYSE, too. In July 2006, the exchange found, the percentage of orders price-improved by specialists was 1.47 percent. A year later, it was down to 0.03 percent. The amount of price improvement provided by other traders also declined. That figure was 10.66 percent in July 2006. It dropped to 1.39 percent in July 2007.

To some observers, the high levels of auto-ex and low levels of price improvement suggest that the NYSE has devolved into nothing more than a large ECN. The open question is whether or not NYSE Group, the Big Board's parent, which also operates the all-electronic NYSE Arca, should be supporting two electronic marketplaces.

The changes have done nothing good for the NYSE's financial picture, either. NYSE Group's margin on its trading activities, which include cash equities and derivatives, was little changed in the first nine months of the year from the same period last year.