Upon Further Review

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One evening this past summer, I ran into Duncan Niederauer on the train system that connects lower Manhattan and New Jerseythe PATH. I was coming off a deadline, and Duncan was on his way home from the BIDS launch party (the crossing network now starting a block-trading joint venture co-owned by the NYSE, as it happens). An unexpected meeting, indeed, as few execs choose mass transit.

The meeting allowed me to catch up with him for the first time since he’d left Goldman Sachs to become co-president of NYSE Euronext’s U.S. trading arm. We chatted, said our goodbyes, wished each other luck. He exited, fittingly, at Exchange Place. Seems his preferred mode of transportation to work is driving his pickup truck to Jersey City and taking the PATH, or driving right to the NYSE. No daily car service for this exec.

Well, I doubt I’ll be running into Duncan Niederauer on the PATH going forwarddespite his regular-guy approachnow that he’s running the show at parent NYSE Euronext. I wish Duncan the best in his new endeavor leading a global organization. As last month’s cover story pointed out, he’s got his work cut out for him.

Niederauer replacing John Thain at NYSE Euronext was one of the big stories of the year. Our cover story this month takes a look at the top trends and stories of 2007. In an era of rapid change, due to increased regulation and advancing technologies, it made perfect sense to put this year in perspective, providing context to the issues in one tidy package. We hope you find the analysis useful.

One favorite story of mine this year probably ran under everyone’s radar. It was actually a tidbit from a story on, of all things, money laundering. The story appeared in the Wall Street Journal on Friday, Sept. 21. It described how drug traffickers are using ATM machines to avoid detection by the authorities: “The deposits and withdrawals are so small, they can pass for ordinary ATM transactions. It’s an extreme practice sometimes called smurfing’the breaking down of large transactions into many smaller ones to evade detection.”

That strategy”smurfing”bears a strong resemblance to algorithmic trading, doesn’t it? It’s certainly worked in equities, allowing traders to lessen market impact and avoid predatory traders. I find it fascinating how a similar strategy can work in two different businesses. Don’t get me wrongI’m not calling for a new term to take the place of “algorithmic trading,” despite the fact that “smurfing” is just two syllables, compared with six, and that it rolls off the tongue more smoothly than “algorithmic trading.” We’ll just have to wait until next year to see what 2008 has in store for algos and everything else.

ITG’s POSIT Blocks Broker Algos

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Investment Technology Group, for the second time, has banned broker-dealers from accessing its POSIT crossing system via algorithms. Citing a desire to increase the average execution size in POSIT, ITG said broker algos could no longer send flow into POSIT on behalf of buyside firms. Institutions must now access POSIT directly or through ITG’s algos.

Chris Heckman, ITG’s co-head of sales and trading, told customers in a Nov. 1 email that crossing systems “dominated by small orders with short durations and small execution sizes perform poorly.We must reverse this trend.” He said POSIT’s executed orders from sellside algos were one-tenth the average size of executions in POSIT.

ITG hopes to increase POSIT’s average execution size to 10,000 shares from its current 4,000 to 6,000-share range, according to Tony Huck, co-head of sales and trading. Huck noted that earlier this year the range was higher, although he declined to be more specific.

ITG chief executive and president Robert Gasser told analysts on the day of the decision that “third-party dark aggregation has not been beneficial to our institutional POSIT constituency.” He said algos, by pushing down POSIT’s average execution size, impaired the buyside’s ability to execute blocks.

ITG made a similar move to prohibit algos in spring 2006, when it put the kibosh on Credit Suisse’s Guerrilla algo’s access to POSIT. At the time, ITG executives said certain dark algos were offering some buysiders cheaper access to POSIT than they could get from the agency broker itself. ITG in subsequent months allowed broker algos to access POSIT as long as they adhered to certain rules.

This time around, the reason for the algo blockade is different. Gasser said the decision to disallow broker algos was made to preserve POSIT as a block venue. That action, he told analysts, is “pivotal to the positioning of POSIT as a premium, differentiated block offering.”

Heckman told Traders Magazine that some brokers offering customers algorithmic access to POSIT appeared to give preference to their own or other liquidity through the algos. He said that adversely impacted the order flow POSIT received.

Dan Mathisson, head of the Advanced Execution Services group at Credit Suisse, said at a recent conference that ITG’s move was a “defensive” attempt to maintain margins for another year or two.

About 10 broker algos were affected by ITG’s decision, according to Huck. Eighty-five percent of POSIT’s executed volume comes from institutions and 15 percent from the sellside, including brokers’ cash and program desks as well as algorithmic flow. The cash and program desks will still have access to POSIT. Huck added that while some buyside desks used broker algos for POSIT access to ease their workflow, some of those algos “weren’t properly accessing the POSIT suite.”

ITG’s decision was foreshadowed earlier this year when Pipeline Trading Systems pulled the plug on customers’ use of sellside dark algos to access Pipeline. In that case, Pipeline said some sellside firms were not aggressively seeking executions in Pipeline, potentially compromising customers’ ability to get the best executions.

Nasdaq Grabs PHLX Options Biz

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Despite more than a year of high praise for the idea of price-time priority markets in the options arena, Nasdaq last month decided to fork over $652 million for the dealer-driven Philadelphia Stock Exchange.

In recent years, Philly has resurrected itself as an aggressive, quote-focused options market. The acquisition gives Nasdaq an immediate options market share of almost 15 percent, bigger than that of NYSE Group, the U.S. subsidiary of NYSE Euronext.

Robert Greifeld, Nasdaq’s president and chief executive officer, told reporters last month that Nasdaq still planned to launch its Nasdaq Options Market, the industry’s seventh options exchange, early this month. The new exchange will have a price-time priority model with pricing that rewards liquidity providers and charges liquidity takers.

Greifeld said Nasdaq would operate two options markets with competing models. He added that he doesn’t see price-time markets replacing market-maker-driven models in the options industry.

The largest U.S. options exchanges, the Chicago Board Options Exchange and International Securities Exchange, are quote-driven markets that together execute 60 percent of the industry’s options volume. The CBOE has a floor and electronic trading, while the ISE is an all-electronic market.

In addition to market share, acquiring Philly gives the all-electronic Nasdaq a floor operation under its direct control for the first time. Philly maintains a hybrid options market, with a floor as well as electronic trading. The exchange also offers electronic equities trading, but its volume is negligible.

The options floor “is an integral piece of [PHLX’s] operation,” Greifeld told reporters, adding that a “substantial piece of the PHLX’s current success is tied to the success of the floor.” He observed that Philly and the new Nasdaq options exchange, with their different market models, are likely to appeal to “different sets of players.”

Nasdaq’s acquisition of PHLX, the nation’s oldest exchange, is expected to close in the first quarter of 2008. Almost 90 percent of the Philadelphia exchange was owned by six broker-dealers, who bought into the market in mid-2005. Meyer (“Sandy”) Frucher, the Philly’s CEO, told analysts last month that the exchange’s agreements with the firms to send order flow to the exchange lapsed last year. “We earned the market share we have,” he said.

For the Philadelphia exchange, Nasdaq’s purchase winds down a decades-long dating game. Frucher acknowledged that his exchange had gotten close to the altar several times. “But I’ve never gotten into the gown until now,” he said. Frucher will remain CEO of the PHLX and is expected to join Nasdaq’s executive management team.

Philly and Nasdaq began negotiations earlier this year and also held talks last year. Over the last two decades, PHLX has held merger discussions with at least four options exchanges and several equities markets.

Liquidnet Beckons Program Traders

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Ten months after acquiring agency brokerage Miletus Trading, Liquidnet is entering the program-trading business with a premium-priced offering. The carrot it’s holding out to buyside portfolio traders is efficient automated interaction with Liquidnet’s pool of institutional orders.

Buyside portfolio traders can now access Liquidnet’s buyside-only crossing network through the firm’s LQTS desk. LQTS, short for Liquidnet Quantitative Trading Services, is the renamed suite of Miletus’s algorithmic trading products. Versions of LQTS algos now provide integrated access to the Liquidnet pool and Liquidnet H2O’s streaming flow from broker-dealers, in addition to executions in the public markets. These algos are called “Supernaturals.”

Liquidnet has 350 members in the U.S., including 80 that are quantitative and 15 that focus on index-related trading. The latter two groups previously “had limited usage of Liquidnet because the functionality didn’t allow them to trade the way they normally trade,” said Alfred Eskandar, head of Liquidnet’s corporate strategy group. “They may trade 500 to 1,000 names at once, and they can’t negotiate 100 at a time.”

The LQTS Supernaturals now enable Liquidnet to vie more effectively for the quantitative trading flow that ITG’s POSIT crosses have captured over the years. ITG, which has many index players as customers, has long offered integrated access to the POSIT products through its suite of algorithms.

This streamlined interaction with the Liquidnet pools has also helped grow the old Miletus business by more than 120 percent over the last six months, according to Richard Johnson, an executive in Liquidnet’s project management group and a former managing director at Miletus. LQTS, he said, now has more than 100 clients, including 30 to 40 new program trading and quantitative accounts that came aboard after Liquidnet acquired Miletus. (Liqudnet eliminated the broker-dealer customers Miletus had when it was acquired.)

LQTS Supernatural algos have a crossing rate of 15 percent to 25 percent for portfolio trades and 36 percent for single stocks, Johnson said. Because of its high crossing rates, which yield large executions with minimal information leakage, Liquidnet believes it can charge a premium rate for Supernaturals.

Traders using Supernatural orders pay 2 cents per executed share, regardless of where they execute. Customers using LQTS’s traditional algos to access the markets continue to pay the commission rate they had previously negotiated with Miletus.

Several program traders told Traders Magazine they are skeptical Liquidnet will convince traders to pay 2 cents per share for all program trades. Liquidnet execs, however, say the savings in market-impact costs more than offset explicit commissions. LQTS has “unique access to the Liquidnet liquidity poolsno other brokerage firm can offer that,” Eskandar said.

CHX Enables Routing Out

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The Chicago Stock Exchange, which currently rejects orders it cannot fill, intends to facilitate participants’ ability to route to other markets. But in lieu of routing those orders itself, CHX has decided to enable firms to select their routing provider.

“Firms can choose,” said David Herron, chief executive of the CHX. “Instead of having an order rejected back to them, they can forward it to a broker-dealer that offers routing.” He said some firms don’t want unfilled orders returned.

Some of the firms that might offer outbound routing from the Chicago are Order Execution Services, Goldman Sachs Execution & Clearing, Citi Lava, Selero and Lek Securities, according to Herron.

In not offering outbound routing, the CHX is an anomaly among exchanges. When the Intermarket Trading System was shut down earlier this year, all exchanges except for the Chicago entered into routing agreements with broker-dealers. The CHX said its customers would prefer to handle their own routing for orders that would otherwise trade through better prices elsewhere.

Now, Herron said, some retail brokers are less keen on that set-up. CHX’s new capability will allow introducing brokers formerly CHX floor brokersto again offer outbound routing to order-sending firms. Floor brokers and specialists previously used ITS to route orders to other markets, before Chicago remade itself along the lines of an ECN.

Herron said CHX’s role would be to facilitate communication between firms. CHX, which does not have a broker-dealer subsidiary, would not be involved in trades routed out. This arrangement is subject to regulatory approval.

TradeWeb Eyes Equities Expansion in 2008

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Thomson TradeWeb, the dominant fixed-income electronic trading platform, plans to broaden its reach to cash equities in the second half of 2008.

Thomson Financial, which bought the over-the-counter trading platform three years ago, will spin out TradeWeb into a joint venture co-owned by a consortium of nine big banks. The banks bought a 15 percent stake in the new entity for $180 million. Seven of the banks were part of the eight-dealer consortium that sold TradeWeb to Thomson in 2004.

Included in the current package are Thomson’s AutEx and the Thomson Order Routing Network. The deal with the banks, which include Goldman Sachs and Lehman Brothers, will be completed in the first quarter of next year.

“We want to offer hedge funds a trading platform that allows them to handle trading strategies across asset classes on one screen,” said Jim Toffey, TradeWeb’s CEO. Those asset classes could include bonds, convertibles, credit default swaps, equities and listed options. According to Toffey, TradeWeb will expand into new asset classes, including equities, through a combination of “organic building and acquisitions.”

The nine banks also committed another $100 million to help grow TradeWeb’s business in these additional asset classes. The dealers will own 80 percent of TradeWeb’s new markets.

A cash-equities trading platform is anticipated for the latter half of next year, with equity options after that. Toffey said TradeWeb could build an upstairs equities block trading platform. An electronic communications network is less likely, he added, although he didn’t rule it out.

“Bringing the equities business under the TradeWeb organization gives us focus and expertise to build out the transaction side,” Toffey said, referring to the trading of equities, compared with routing and the current AutEx indications product. “It’s ultimately about having liquidity. We’ll work with dealers and the buyside to help put the [fragmented] market back together.”

TradeWeb will also make AutEx, its indications-of-interest and trade-advertisements product, more electronic and executable. This overhauled product, as well as any other TradeWeb trading platforms, could use the firm’s FIX-based routing network. The network, which has 7,000 connections and handles more than 15 percent of U.S. volume in traded equities, will be renamed TradeWeb Order Routing Network.

The nine banks that will have a stake in TradeWeb are Credit Suisse, Deutsche Bank, Goldman, JPMorgan, Lehman, Merrill Lynch, Morgan Stanley, Royal Bank of Scotland and UBS. The new company will retain the TradeWeb name and the 400 current employees, half of whom are developers.

Knight Buys an Algo Presence with EdgeTrade

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Knight Capital Group, which earned its stripes as a dealer, is looking to increase its presence in the agency trading game via algorithms. Last month, the giant trading firm bought agency brokerage and algorithmic provider EdgeTrade for about $59.5 million in cash and unregistered stock. The purchase gives Knight EdgeTrade’s suite of algorithms and smart order-routing.

“They’ve identified a gap in their product arsenal,” said Carl Carrie, an electronic trading exec at JPMorgan. “What they don’t really have are algo trading and an execution management system as products. So, apparently, with this acquisition they fill those gaps.”

Knight plans to offer clients EdgeTrade’s algorithms through its DMA application, Knight Direct, early this month, said Bill Cronin, managing director and head of the dealer’s electronic product sales. He described Knight’s existing algos as mostly “very basic VWAP and TWAP” algos.

Roderick Burns, a Knight exec, said many of Knight’s clients are stepping up their algo usage. “We’re seeing interest in performance-based algos,” and in sector- and cap-specific strategies, he observed. The EdgeTrade acquisition gives Knight new capabilities to design algos geared to those strategies.

Additional flow from algorithms could also enable Knight to increase its internal crossing opportunities for agency flow through Knight Match, its ATS. Cronin said Knight could cross more order flow internally if that “provides faster, more price-improved executions to the end customer.” New York-based EdgeTrade will operate as a separate subsidiary of Knight.

Niederauer Gets Nod at NYSE Euronext

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Can electronic trading veteran Duncan Niederauer step in to replace John Thain as CEO of NYSE Euronext without missing a beat? Industry execs emphatically say yes. The pragmatic Niederauer, they say, will have no problem filling the shoes of Thain, who left to head Merrill Lynch last month.

Niederauer joined NYSE Euronext as co-president in April from Goldman Sachs, where he spent 22 years. “This guy’s a pro,” commented the head of trading at a large brokerage firm. “Duncan is strategically savvy and smart.” Sources describe Niederauer as competitive, energetic, direct, hard-driving and client-focused. He’s not afraid to take on new projects, said another trading veteran.

However, the new CEO will face a learning curve, said a former client. The two aspects of the new job are running a business, but also being an ambassador of sorts on a global basis. “From a political acumen perspective and in a global context, this is a new area for him,” the former client said. “Duncan isn’t a politician, but I think he’ll be fine.”

On The Move

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Frederic Krieger joined NYSE Regulation to lead a new risk group, charged with identifying, tracking and addressing key external market and industry trading developments that require regulatory responses, as well as internal areas of risk. Krieger will report to Robert Marchman, executive vice president, enforcement and risk division. Krieger was most recently managing director of Riverview Capital Holdings, a private investment firm based in New Jersey. Krieger has also held compliance jobs at Citi and Charles Schwab.

Robert A. Schwartz was awarded the Lirtzman Prize by the Zicklin School of Business at Baruch College last month. Schwartz, a professor of business for 43 years, received the award for his 11 years of research, teaching and service to Baruch College, according to John Elliott, the business school’s dean. Schwartz was among a handful of academics pioneering the study of what later became known as “market microstructure,” which examines how securities markets operate and how orders are priced and traded. Guest speakers at the award ceremony included Harold Bradley, chief investment officer of the Kauffman Foundation in Kansas City, and Reto Francioni, CEO of Deutsche Borse.

Jenny Miller joined Bear Stearns in London as a senior managing director and head of portfolio trading sales for Europe. Miller, a 14-year veteran in portfolio sales, joins from Merrill Lynch, where she headed portfolio sales. She has also worked in portfolio sales at UBS and BZW. Her hiring follows that of Richard Bateson, who joined Bear’s European portfolio trading team as a managing director earlier this year. Bateson, a 10-year veteran in portfolio trading, had worked at JPMorgan in portfolio trading, where he was responsible for risk and flow trading.

Scott Bauer took a sales position with Investment Technology Group. He was previously at LaBranche Financial Services in a sales capacity.

Nick Savona recently joined Toronto-based Evergreen Capital Partners as a sales trader at the boutique investment bank. Savona, a 15-year trading veteran, will cover Canadian accounts, but his initial charge is to get Evergreen registered with FINRA, so it can trade with U.S. institutions. Savona previously headed the U.S. trading arm of Toronto-based MGI Securities for two years before moving to Evergreen.

Ed Laux was promoted to head of U.S. trading at Cantor Fitzgerald, a new position. Laux was head of listed trading at Cantor. Also at Cantor, Tony Manzo, head of OTC trading, is retiring from that position. Manzo will stay with Cantor in a consulting role. He is being replaced by William Clark and Michael Ferry as co-heads of OTC trading. Clark was a senior OTC trader at Cantor. Ferry is new to the firm.

Laurie Berke joined TABB Group as a senior consultant in the firm’s New York office. Berke has been working with TABB since early 2006 as a consultant on an informal basis. Before that she spent 10 years at Investment Technology Group in global execution services product management. There, she was responsible for the desktop product QuantEX, the early development of the EMS Triton, ITG’s first algorithmic servers, the launch of ITG Canada’s trading systems and their global portfolio trading system.Prior to joining ITG, Berke spent five years at Merrill Lynch, where she served as a senior vice president responsible for the launch of its portfolio trading and derivatives business.

Jefferies Group made two hires in its London office. The brokerage brought on Terry McCarthy as head of U.K. trading and sales trading and Steven Hopwood as deputy head of U.K. trading and sales trading. Both executives join from Panmure Gordon & Co., where they held similar positions. In their new roles, they will be responsible for leading the development and coordination of Jefferies’ U.K. equities business, as well as the sales trading business with European investors.

Gary Canon, head of equity trading at Harris Investment Management in Chicago since 1996, will retire next month after 38 years as an equity trader. Canon, who also spent six years as a sales traderincluding a stint at Drexel Burnham Lambertstarted on the trading desk at First Chicago in 1969. Canon was president of the Security Traders Association of Chicago for two years, in 1984 and 1985. Phil Krauss, a current staffer and veteran trader at Kemper Financial and UBS Asset Management, will become the new head of equity trading.

Cuttone & Co. hired five new sales traders and a strategist. Patricia Fleming, Sue Conway and Ted Clarke all join as senior vice presidents from Prudential Securities. Cuttone & Co. also hired John Greco, formerly of UBS, and Gary Curreri, formerly of Jefferies & Co., as senior vice presidents in sales trading. Bernie McSherry, also from Prudential, joins as a senior vice president to bolster the firm’s marketing efforts and strategic initiatives.

Ralph Edwards recently joined Sanford C. Bernstein & Co. as a senior vice president to launch an options trading desk. Edwards, a 25-year trading veteran, previously ran the options desk at Prudential Securities for three years. Bernstein expects the options desk to be fully operational early in the first quarter of ’08. Edwards reports to Tom Wright, global head of equity trading.

Paul Buckley recently joined Credit Suisse as a director and salesman for its AES’s FX product. Buckley, who previously worked at UBS for 10 years, reports to Manny Santayana, managing director and head of AES sales.

Marc E. Lackritz, 61, will be stepping down as president and CEO of the Securities Industry and Financial Markets Association, or SIFMA, once a search committee has named his successor. Lackritz has been president of the organization and its predecessor, the Securities Industry Association, since 1992. Lackritz has plans to teach on the university level and is working on a book idea. A savvy veteran of Capitol Hill, Lackritz has spent most of his career working with various industry associations. Prior to that, he was staff director and chief counsel for the Subcommittee on Telecommunications and Finance of the House Energy and Commerce Committee. He has been deputy chief counsel to the Senate Budget Committee, and was an assistant counsel to the Senate Watergate Committee. He has testified before Congress on numerous occasions and has spoken and written extensively on issues facing the financial services sector.

Credit Suisse trading veteran Tom Rice has made a career move that could ultimately affect the careers of other Credit Suisse employees. Rice, previously a managing director and head of U.S. equities sales trading, has moved from trading to Credit Suisse’s human resources department. There, Rice remains a managing director and heads an “internal mobility” initiative that grooms talented employees for more senior roles in the firm. Rice, who’s spent most of his 27-year trading career at Credit Suisse, co-chaired this year’s annual Muscular Dystrophy Association’s fund-raiser gala, Wings Over Wall Street. Wings Over Wall Street has become the most successful event for ALS (Lou Gehrig’s disease) in the U.S.

2007 Review: A Rocky Regulatory Marriage

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It can be easy to merge. But it is not so easy to make it work. This was the year the promised cost-saving merger between the NASD and NYSE Regulation finally happened. But now regulators, who are normally sensitive about protecting turf, must agree on different trading rules if the merger is to be a success.

Part of the goal of the much-ballyhooed regulatory merger is to provide the trading industry with one standard for how customer orders are treated. Indeed, the trading industry, says Richard Ketchum, NYSE Regulation CEO, “deserves to have a single approach.” But there will be plenty of grunt work before that happens.

Case in point: Can NYSE regulators find a way to meld the Financial Industry Regulatory Authority’s Manning rule, also known as Rule 2110, with NYSE Rule 92? Manning applies to NMS and over-the-counter securities; FINRA eased its rules in the latter area this year (see following item). NYSE Rule 92 covers listed securities. The rules specify how customer limit orders are treated. The rules also contain exceptions. But the rules also have different disclosure and compliance obligations.

Ketchum says some harmonization work has been done. Manning and Rule 92 regulations are now much closer. Take NYSE’s recent adoption of provisions allowing riskless principal trades entered off the floorthat provision made Manning and Rule 92 more similar. Nevertheless, some differences remain, Ketchum adds, and they are of critical importance to NYSE members.

Inevitably, compromise is going to be necessary on the part of NYSE Regulation and FINRA. For instance, Manning and Rule 92 cover market center activities. But those rules, which provide oversight of NYSE member firms, are not part of FINRA’s consolidation efforts. And, merger or not, NYSE Regulation says it remains the regulator of its member firms.

“Trading rules still remain the responsibility of NYSE,” Ketchum says. “It didn’t give up its oversight of its trading rules.”

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