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May 9, 2008

NYSE Specialists Get Break on CAPs

By Peter Chapman

The New York Stock Exchange, as part of a broad-based initiative to shore up specialists' competitiveness, will permit them to trade CAP orders on parity with other orders.

Currently, specialists handling CAP, or convert-and-parity, orders for floor brokers must cede any trade to a competing DOT or other agency order at the same price. Under the exchange's proposal, CAP orders will have equal standing with DOT or other agency orders.

The proposed change to rule 123A.30, which must be approved by the Securities and Exchange Commission, is just the latest in a string of moves by the NYSE to relieve the specialist of some of the rules restricting his trading activities.

The move is considered minor, though, in light of the fact that the use of CAP orders has dropped significantly, and also because the NYSE is likely to eliminate the venerable trading tool altogether in the near future. "We are exploring the replacement of CAPs with more effective alternatives that better respond to broker and customer input," an NYSE Euronext spokesperson said.

CAP orders are also known as go-along orders because they are institutional orders that are executed along with general price trends. They never set the price.

The orders, which are left with specialists by floor brokers for representation, have been subordinate to other agency orders since their creation in the mid-1980s. Behind their second-class status were SEC concerns that specialists could use CAP orders to manipulate the market.

The restrictions are obsolete, the NYSE argues in its request for SEC approval, because of changes in market structure and trader behavior. First, due to the NYSE's loss of market share, the specialist has less influence over the price of a stock. The NYSE floor, which once controlled about 80 percent of the volume in NYSE-listed securities, now handles just 40 percent.

Second, CAP orders must be "activated" manually. The inherent delay makes their use by specialists as a tool of manipulation less likely in the high-speed trading environment of today's NYSE floor.

Finally, CAP orders are less common, and therefore less of a threat to market integrity, the NYSE argues. They have been supplanted to a large degree by floor brokers' use of electronic reserve orders, which often achieve the same results. In March, there were 2,125 conversions, or activations, per day of CAP orders. That is down from 4,401 conversions in October 2007 and 6,762 in June 2007.

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