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Bill Lillwitz, Melvin Specialists, Chicago; Paul Richards, DME Securities, Jacksonville; Jeff Christanell, Huntleigh Securities, St. Louis; Billy Cahill, SunTrust Robinson Humprey, Atlanta.
Mary McDermott-Holland, profiled in this month's cover story, assumes her new role as
chairwoman of the Security Traders Association at a critical moment in regulatory history. The job comes with a heavy load. But the popular Boston buyside trader can handle it. McDermott-Holland's job is formulating a logical set of policies for a group that is trying to be more than just a sellside, Nasdaq-oriented trade association. McDermott-Holland, who succeeds the equally popular Jack Hughes of Philadelphia, must meld the concerns of buyside and sellside constituents into sensible but far-reaching policy. But these must be policies that reflect the best interests and traditions of a diverse organization. The STA includes market makers, buysiders, alternative trading systems and the traditional brick and mortar type stock exchange traders. It won't be easy. Can the industry satisfy the demands of market makers, for instance, while not stepping on the toes of the ECNs? Can it persuade the buyside and sellside to be nice boys and girls? How about reforming the Intermarket Trading System so that NYSE off-board trading pros can have better access to the listed markets? That action would alienate some powerful interests of the NYSE, which has its own group of pros, a group that seems to ignore the STA. Still, successfully representing these various groups is possible. McDermott-Holland, in her own charming fashion, may get it done. She can count on STA President John Giesea, a man of principle and professional accomplishment.
Finding common ground is nothing new at the STA. It recently published a White Paper on market structure, a document that showed how difficult it is to reconcile its own lofty goals with the obvious objective of every trading professional: making money in a capitalist market. The STA identified fragmentation, market linkages, ECN access fees and regulatory arbitrage as areas ripe for immediate reform. The STA said the most important criterion is that each market center be judged on whether it impedes or promotes the National Market System (NMS).
The STA should be commended for its bravery. Carrying out its mission risks alienating many of the same traders that the STA wants to represent. After all, the NMS puts the welfare of individual investors before the goals and best interests of the professional trading community. Nevertheless, the STA's White Paper notes the lunacy of the current policy on access fees. It contains the example of how a broker might be profitably served by locking a market, instead of hitting a bid, thereby earning a small rebate. Unfortunately, these same outrageous rebates and access fees have become embedded in the business model of various ECNs and market centers. Convincing these groups that access fees should be abolished so the goals of the NMS can be accomplished is a big job. Muy buena suerte, Mary. And may the wind be at your back.
John A. Byrne
Editor
john.byrne@thomsonmedia.com
Bulletin Board
*The OTC Bulletin Board is hot. The nation's second tier over-the-counter market saw both its share and dollar volume soar in July. Trading leaped 272 percent to $3.5 billion in dollar terms over July of the previous year. Shares traded jumped 35 percent to 19 billion in the same period. Share volume in the penny stock mart has recorded nearly continuous month-over-month increases since bottoming out last October. The leader generating the most trades is Knight Trading Group. Knight traded 7.4 billion OTCBB shares in July, according to the OTCBB. That was nearly triple the volume generated by each of its closest rivals, Schwab Capital Markets and GVR/E*Trade. Knight said it executed about 32,000 OTCBB and Pink Sheets trades daily in July, up from nearly 13,000 a year ago. OTC volume accounts for over half of all shares traded by Knight.
Options
*Upward or downward volatility in the stock market results in higher options prices, which means puts and buy calls become more expensive. That's the conclusion of a new study by a professor at the University of Michigan Business School. Professor H. Nejat Seyhun says these findings emphasize that the pricing options in the markets are more involved than the economists standard option-pricing formulas indicate. "Our results suggest that recent stock returns exert an important influence on index option prices," Seyhun said. "This creates opportunity as well as potential problems for investors who trade options." In a study forthcoming in the Journal of Business, Seyhun and colleagues Kaushik Amin of Lehman Brothers and Joshua Coval of Harvard University examined the Standard & Poor's 100 index option prices from 1983 to 1995. "Investors must plan ahead if they trade options," Seyhun said.
Block House
*A veteran of the third market has launched a new institutional trading house. Steve Braverman, formerly head trader in the Knight Capital Markets division of Knight Trading Group, is president of Block Orders Execution of Westbury, N.Y. The seven-person firm is a unit of Secure Trading Group, a proprietary daytrading outfit based in Boca Raton, Fla. The new firm will solicit block limit orders from mostly retail brokerages. It will attempt to build a book of liquidity that can be marketed to the buyside. Strictly a listed shop, it plans to trade about 500 names in the Nasdaq InterMarket under the STGI moniker. Block Orders is charging two cents a share to the buyside for orders of 250,000 shares or less. Orders over 250,000 shares are free. The shop may rebate the sellside a quarter-cent for its limit orders. Braverman spent 10 years at Knight before joining a small brokerage called Alexander Wescott in 1997. At Wescott, Braverman ran a third market block desk. Wescott shut down its market making operation about 12 months ago.
Exiles
*The former Deutsche Bank Global Securities Services (GSS), now a part of State Street, is moving most of its 300 staffers in the New York City metropolitan area to a new office at Two World Financial Center in Lower Manhattan. The GSS operations in the U.S. had been located at 130 Liberty Street, beside the World Trade Center. Although the Liberty Street building remained intact after the September 11 terrorist attack, the facility was said by authorities to be a health hazard. A bigger issue for State Street officials is retaining the revenues and clients of GSS. State officials claim that they are going to be able to retain about 90 percent of GSS's revenues. However, several State Street competitors dismissed that number, contending it is wishful thinking.
With the United Kingdom's Financial Services Authority taking a tough new stand against soft-dollar practices, the Securities and Exchange Commission is also expected to clamp down. That's what several participants said at a recent conference on soft dollars and directed brokerage sponsored by the Institute for International Research.
Jay Barris, a private securities attorney, said the SEC is trying to rein in soft dollars. He also pointed to a report on rising mutual fund fees and a pending bill in Congress by Richard Baker (R.-La.) – which calls for greater disclosure of fund charges – as examples of regulators and lawmakers moving in the direction of discouraging the use of soft dollars.
The conference explored this issue: Will the American authorities, following the lead of their British counterparts, abolish soft-dollar practices or reform them?
"Personally, I don't think soft dollars are going to go away in the next few years, but maybe there will be some changes around the edges," said Gene Gohlke, associate director in the SEC's Office of Compliance, Inspections and Examinations. [See Special Feature.]
Meanwhile, the National Association of Securities Dealers has joined the movement for greater scrutiny of mutual fund costs. A proposed NASD rule would require firms to disclose their execution policies and brokerage relationships. The rule would also mandate firms to disclose if they receive any other compensation besides that described in a prospectus.
Nasdaq has filed with the regulators for permission to conduct subpenny trading. This is even though Nasdaq officials have previously said that they believe subpenny trading can cause serious harm for the trading industry.
"They're taking a smart position. They want the ability to do it if the practice becomes widespread," said a Nasdaq trader, who didn't want to be quoted by name, but was acquainted with the proposed rule change and petition.
"The Nasdaq move makes sense because their electronic counterparts don't need a rules change to be able to suddenly do it and outflank them," the trader said. Island, Instinet and Brut are among the ECNs that allow subpenny trading. A trading industry executive speculated that Nasdaq is ready for the SEC to reject its request. "Then they'll be able to say to the SEC that there's an uneven playing field and they should rein in electronic firms doing sub-penny trading," said the executive.
John Heine, a spokesman for the Securities and Exchange Commission, confirmed that the Nasdaq filing has been made.
Nasdaq officials didn't respond to repeated requests for comment. However, Rick Ketchum, who left Nasdaq earlier this year and who had been serving as president, said that subpennies, if approved by regulators, would provide an unfair advantage in various circumstances.
Subpenny traders, said Ketchum at a conference at Baruch College, can "step in front of other orders with sub-pennies because systems like Lava will recognize them and put such orders ahead of others."
The U.S. Senate Subcommittee on Securities and Investments will be holding "at least one and maybe two hearings on market structure sometime this fall," according to a staff member.
"The hearings will be broad and we will be taking testimony from all the major players in the securities industry," said a committee spokesman. The spokesman said the witnesses and the exact dates of the hearings have yet to be determined.
The next few weeks will be a critical period for the Security Traders Association.
As Traders Magazine went to press, the association was continuing its full-court press of lawmakers and regulators, seeking to make its case on various issues in person.
At the top of the list will be the STA's attempt to end access fees, revise decimalization and persuade regulators to let it have a say in the move toward other market structure reforms.
Correspondence
"We've given them a White Paper on market structure and had frequent correspondence with the SEC. Now we intend to meet with many of them in person over the next two weeks," John Giesea, president of the STA, recently told Traders Magazine.
Giesea and other members of the STA board are slated to have a face to face meeting with William Donaldson, the new chairman of the SEC, as well as other SEC commissioners and staff.
Besides providing members with their unique point of view, STA officials are also hoping that they will be active participants in the expected hearings on market structure that are slated for a subcommittee of the U.S. Senate Banking Committee.
"We want to be a part of any of these hearings. We are hoping that the committee will be interested in the STA giving testimony," according to Mary McDermott-Holland, the incoming chairwoman of the STA.
The committee, according to a securities industry lobbyist, may or may not decide to take testimony from associations such as the STA and the Securities Industry Association.
Testimony
The lobbyist said that the committee may instead decide to hear from the traders themselves.
If so, then McDermott-Holland would likely give testimony. She is both a buyside trader and an association activist, the lobbyist said.
"The hearings will be very important," the lobbyist added. You can be sure that the SEC will be watching these hearings very closely."
Decimalization, which is expected to be one of the topics on the market structure agenda in Congress, is not working for most block traders, according to a new survey.
About 80 percent of some 50 block traders surveyed said that decimalization has been a "net negative" for their clients. And, by about the same percentage, block traders said decimalization should be modified, according to the survey by Harborside+. Harborside+ operates a block trading system. The survey was sent to 233 traders on the buyside and sellside.
Asked if the solution should be a minimum increment or to widen the spreads for everyone, 95 percent of respondents said that everyone's spreads should be widened.
The Evidence
"These results suggest that decimal trading is still not broadly accepted among institutional block traders," said Michael Cashel, chief operating officer of Harborside. The survey was sent via e-mail.
The NYSE floor-based trading system is not maximizing the interests of those who actually own the order flow so its ownership base should be expanded. That's according to a scholar who has been studying market structure and recently sent a letter to the Special Committee on Governance of the NYSE.
Benn Steil, a senior fellow with the Council on Foreign Relations, is calling on the NYSE to "revisit" the issue of demutualization. The latter is an option that, he says, would solve many cost and potential conflict of interest problems.
"First, the endless public and regulatory debate over whether the NYSE chosen market structure exists to serve the interests of investors or those of the intermediaries that currently own the exchange would become moot," Steil wrote.
"Second, the compromise and consensus that now dictates how the interests of the Exchange's owners are reconciled with those of the investing public would be replaced by a governance process which ensured that this conflict did not exist in the first place," he added.
The Big Board's ownership structure would be improved by having "nonintermediaries" included in the decision making process. Steil noted that his research with industry expert, Ian Domowitz [now with ITG], calculated that a 10 percent decline in trading costs in the major U.S. and European equity markets results in an eight percent higher turnover. "If this is even a modest approximation of reality, it is clear that a commercial NYSE would, in its own interest, choose a market structure that encourages investors to trade by eliminating any unneccessary intermediation costs," Steil wrote.
Steil is confident the NYSE is listening. "They seemed to give me a respectful hearing," Steil told Traders Magazine. However, he believes that the committee has no intention, at this point, of accepting his reforms. "But if the NYSE were to lose market share, if the price of seats were to start to drop, then I think that my ideas might be used," Steil said. Steil's comments come as the NYSE puts on a brave face following an examination of controversial floor trading practices by the Securities and Exchange Commissions and the exchange itself.
The NYSE said the committee will unveil its recommendations soon.
Financial institutions would be required to maintain a photocopy of the documents establishing the identity of foreigners who open accounts with U.S. firms under a proposed regulation of the Patriot Act. And that, says the Securities Industry Association, in a comment letter to the U.S. Treasury Department, would be an onerous rule.
"Requiring the copying of identification documents would be an ineffective use of resources and would increase burdens and costs without adding meaningfully to the safeguards financial institutions are implementing," wrote Alan Sorcher, associate general counsel of the SIA. "Making and retaining copies also presents several insurmontable operational issues for financial institutions."
Treasury is considering the final issue of regulations under the Patriot Act.
Meanwhile, it will cost securities firms, banks and insurers from $100,000 to $10 million each to comply with the Act's anti-money laundering regulations (AML), according to a study by Celent Communications, an industry research firm.
Celent also predicted that within three years $11 billion will be spent to comply with the Act's AML regulations.
"AML compliance spending could represent $10 billion more than Elliot Spitzer has been able to shake out of the securities industry for research indiscretions," according to Chris Poelmo, chief executive of Comprehensive Software Systems, a financial services software firm. "Nevertheless, there is still no excuse for not complying with the minimum requirements of the Act, many of which are not exceptionally expensive," added Poelmo, in a commentary on the Traders Magazine Website, tradersmagazine.com.