The Securities and Exchange Commission gave it the green light, but some on the buyside are still grumbling.
Two years and eight amendments after it was proposed, NYSE Group's hybrid market plan won SEC approval. The new market structure for NYSE Group's New York Stock Exchange subsidiary is scheduled to be fully operational by the end of next month.
The blend of automated and human trading "should provide investors with a more efficient mechanism to have their orders executed on the Exchange," the SEC stated in its approval order.
The regulator also believes the hybrid will offer traders faster access to NYSE quotes and "could enhance the opportunity for a customer's order to be executed without dealer participation."
Such happy talk did not ring true to many of the New York's critics.
They warn that they will be hesitant to use the new Big Board because of the privileges to view orders given to specialists, and, to a lesser extent, floor brokers.
They argue that NYSE specialists will "disincent" the placement of public limit orders.
"Who will want to enter a fully-displayed limit order," one buysider asks, "that attracts contra-side liquidity, only to have, particularly in sweep transactions, a hidden order entered later in time grab the execution and shut out the displayed public limit order?"
Nevertheless, defenders of the hybrid plan, conceding that it gives specialists advantages, argue it is justified. That's because it means the NYSE will offer more effective price improvement at the same time that it preserves specialist firms, hybrid defenders say.
"The NYSE has enhanced the ability of the specialist to make money, but only by the specialist providing value-added services," said an official of a specialist firm who didn't want to be quoted by name.
Still, the changes in the hybrid plan will hurt clients and obligate traders to seek other trading venues, critics insist.
"The hybrid may be a great place to hit and take liquidity, but it will not be a good place to post. It will become an execution venue of last resort," warned one buyside trading official, who declined to be quoted by name.
The NYSE, in the eighth amendment, wanted to save the specialist position. So Big Board officials proposed to permit specialists to participate electronically in the hybrid market.
An example of this is providing specialists with information about incoming orders before they are processed by the Display Book system. Using their own algorithm, specialists would be able to make limited quoting and trading decisions in response to incoming orders. These would include providing "price improvement, improve the Exchange BBO, or supply size to fill the incoming order at the Exchange BBO," according to the eighth amendment.
In a comment letter and an interview with Traders Magazine, one prominent critic contends the SEC made a Faustian bargain.
"Why were specialists the big winners here?" asked George Rutherfurd, a Chicago-based consultant to two trading organizations.
"It appears that the NYSE somehow convinced the SEC staff that the NYSE specialist system (monopolistic, unitary market makers) would not be economically viable going forward unless specialists were given these hitherto unimaginable competitive advantages to the detriment of the public orders," Rutherfurd wrote in a comment letter. "And the SEC staff, at least in the near term, were spooked enough by the (bogus) prospect of a primary market's market making system going down the tube that they gave NYSE specialists carte blanche here. It's a classic deal with the devil," according to Rutherfurd.
A buyside executive agreed with the critique. He said that, because specialists are receiving an algorithm and floor brokers will have a discretionary order, this "totally contradicts the original intent of the hybrid model, which was to protect limit orders on the floor."
This buyside executive, a trading official with a large investment company, wouldn't be quoted by name. He added that it is "now basically foolish for us to post at the NYSE."
The buysider added that the NYSE had won the battle for order flow with the approval of hybrid, but would lose the war once Reg NMS becomes effective. Reg NMS, he said, will push buyside firms to look for other trading venues.
Still, Richard Rosenblatt, founder of Rosenblatt Securities, said the NYSE in the hybrid plan found a unique way of providing better execution while still giving specialists the chance to survive.
"A specialist algorithm can see an incoming order but only can react by improving the price or the volume to the advantage of the incoming order," according to Rosenblatt, who runs a floor brokerage.
The eighth and final amendment to the proposal did slap new restrictions on the specialist and his use of algorithms. There were at least three key changes. First, specialist firms must create and maintain records of all messages generated by their algorithms. Second, specialists must hire auditors to review their algorithms on an annual basis.
Finally, the definition of "meaningful amount" was amended for purposes of determining when a specialist could provide price improvement.
A meaningful amount now constitutes at least 1,000 shares for the 100 most active securities on the exchange. This would be based on average daily volume, and at least 500 shares for all other securities on the exchange, according to the eighth amendment. A list of the 100 most active securities on the exchange will be published at least on a quarterly basis.