The increasing transaction volume on Nasdaq and the New York Stock Exchange was fueled by a seminal event the unbundling of fixed commissions in May 1975. Until then, Wall Street trading houses did not use their commissions to compete.
Whatever semblance of competition there was revolved around the value of prep-school connections, and gastronomic accounts at the most posh restaurants in town.
As soon as brokers started competing with commissions, however, two forces were unleashed: a steady increase in stock transactions as prices tumbled, and the closure of dozens of firms crippled by unproductive backoffices.
The backoffices of Wall Street were a source of constant crisis throughout the 1960s, when the deluge of manual processing threatened to overpower the capacity of the NYSE and its member firms. Soon after May 1975, a streamlined, sleek backoffice was an essential component of a profitable firm.
As commissions tumbled, the subsequent squeeze on profit margins reduced the subsidy available for handling stock transfers, recordkeeping and settling trades. And people in Victorian-era backoffices lost their jobs.
The unbundling of commissions had another effect: It triggered the start of the soft-dollar business in place today, as a safe-harbor law allowed brokers to claw back the cost of providing research and other services to institutions.
The Technology Curve
If the unbundling of commissions meant the elimination of inefficient firms, it did so as Wall Street trading firms scrambled to upgrade their processing and trading systems. At the same time, the microchip processor and digital communications were in the ascent, opening the way for unprecedented change.
Junius Peake, who in 1961 started running the 700-person backoffice at New York broker dealer Shields & Co., was scoffed at when he presented his blueprint in 1976 for the creation of a nationwide electronic marketplace.
His vision was in line with the unbundling of commissions and most importantly, the National Market System mandated by Congress a year earlier.
Today, the realization of a national market system linking investors, market makers and price-quote vendors with the best-available prices at the moment of execution, is taking shape.
And thanks to the intersection of technology and regulation, Wall Street trading desks are embarking on more change change unimaginable a few short years ago.
Peake, now a finance professor at the University of Northern Colorado, compares the current pace of change to curves joined and shaped like the letter "s." The left side represents the introduction of a new technology, which in this instance means the microchip in the 1960s.
At the beginning, the pace of change is slow, gathering momentum towards the middle, later peaking at the top. "We are about one-third of the way along this curve, and I would say we have about another 50 years to go before we will peak," he said.
The effects could be profound for Nasdaq market makers and other traders.
"There will be a strong dealer component in the marketplace over the next few years. But only a hundred market makers will be actively doing business," predicted Kenneth Pasternak, president and chief executive of Nasdaq market-making giant Knight Securities. Currently there are roughly 500 active market makers in the U.S.
"The history of market making is going to look a little like the history of the U.S. car industry, starting in 1910. Then there were 55 car companies," Pasternak added. "To stay in business, market makers will have to become technology enablers to attract order flow and to provide the [best] possible executions."
To be sure, some small firms will make money specializing in issues dropped by the largest market makers. But other small firms will likely be swept away by the competition, experts say.
The explosive use of the Internet for online trading, research, market-data delivery and, quite possibly, market making in the near future, is an obvious manifestation of the upheaval.
Scott Appleby, an Internet technology analyst at investment-banking giant ABN Amro, said large broker dealers in the past had the advantage of superior information and research.
"Now a guy in his house in Vermont can get Nasdaq Level 11 quotes and real-time information for a nominal sum," he said.
Nowadays, the data traders obtain from the Internet provide an additional level of information and analytic support. (The data, though, is still not viewed by trading professionals as a substitute for proprietary information.)
"I think those firms that are not online now really need to be online soon," said Dave Kansas, editor of The Street.com, a financial news service that delivers market information via a web site and an intranet feed.
"It's a new world out there," said Marty Cunningham, senior vice president of equity trading for Jersey City-based Mayer & Schweitzer. "New technologies, most significantly the Internet, are becoming critical."
The 19th Century
During the last century, more than 200 stock exchanges, mostly built with brick and mortar, opened in America. In the closing months of the 20th century, a different kind of stock exchange is emerging.
The new kind does not have physical floors where traders gather, buying and selling securities. Instead, these exchanges are virtual or electronic exchanges, connecting investors, market makers and institutional buy-side firms.
Actually, the new exchanges are already in business as electronic broker dealers. But they are changing.
The Securities and Exchange Commission is encouraging them to take stock-exchange status, saying it is unfair to have them operate as de facto exchanges without the same supervision as regular exchanges. Alternatively, the SEC said it will subject these electronic brokers to increasing regulation as broker dealers.
Either way, the SEC is requiring these alternative trading systems (ATS) to transmit their price quotes to a listed exchange or to the National Association of Securities Dealers, so that the data can be immediately transmitted for public broadcast. The aim is to make price quotes carried by ATSs as accessible for execution to individual investors as they are to institutions.
Most ATSs are expected to remain as broker dealers, but others are jumping on the stock-exchange bandwagon. Brooklyn-based Datek Online Holdings' Island, which has overtaken Instinet's advertised Nasdaq trade volume, said it wants to become a stock exchange.
"Alternative trading systems have a great deal of potential to change the way trading takes place," said Brandon Becker, former director of the SEC's division of market regulations, and a partner at Wilmer, Cutler and Pickering, a Washington-based law firm. "There's potential for new systems to come online within a year," Becker said.
Knight Securities said it may ink a deal with a full-fledged ATS, or else foster its own for the purpose of becoming a stock exchange. (Knight Securities is arguably an ATS, automatically matching a huge proportion of the buy and sell orders electronically routed to the firm. The firm is a minority owner of the BRUT ECN.)
"We are weighing up our options," Pasternak said. "We've been approached by every ATS and every existing non-primary stock exchange [about creating an alliance]."
Just as the telegraph in the last century swept away all but the strongest stock exchanges, today's high-speed digital computers are catching some players flatfooted.
As investors think more globally, stock exchanges are forming alliances to preserve franchises and are adopting strong trading systems. Technology has the potential to bring institutional buyers and sellers together anonymously with minimum market impact. The first guinea pig: The OptiMark Trading System that went live last month as a facility of the Pacific Exchange, presenting an immediate threat to the future of the Big Board.
With the price of a Big Board seat having tumbled from a year ago peak of $2 million to just over $1 million today, the exchange is naturally concerned about the value of its franchise.
Responding to the threat posed by OptiMark and the alliance of Nasdaq and the American Stock Exchange, the NYSE developed an electronic system for block trades called Institutional Xpress. OptiMark, meanwhile, is planning to access Big Board-listed stocks via the Intermarket Trading System.
Bricks and mortar are, alas, no longer solid. John Edward contributed to this story.