After about three decades of remarkable growth by the stock exchange "for a digital age," the stage is set for a brutal battle between Nasdaq and the Big Board. Nasdaq is now far too big and far too noisy to be ignored. The battle will be waged on many fronts–in the fight for listings, on the web and in many places outside of the United States.

The acquisitions of market making firms by significant Wall Street players – market makers that include starlets such as Herzog, Heine Geduld; Spear, Leeds & Kellogg; PaineWebber Inc. – is one indication that Nasdaq is no longer the obscure exchange for OTC stocks.

"Today, everybody wants to buy these [market-making] franchises," said Bernard Madoff, chairman of Bernard L. Madoff Investment Securities, a Nasdaq dealer and third market firm.

Although the market capitalization of its firms, $16 trillion last year, makes it larger than the Nasdaq (where the market capitalization of its firms was about $5 trillion in 1999), Nasdaq has become much better known with the general public in the U.S. and the U.K. than the 200-year old Big Board.

That's according to a survey conducted for Nasdaq by Response Analysis Corporation, a market research company in Princeton, N.J.

In a relatively short time, Nasdaq has greatly benefited from America's dizzying shift to an information economy. All of a sudden, the once dinky little exchange has some 5,100 companies.

But, more importantly, are the kinds of the companies it has – Microsoft, Cisco Systems, Intel, Starbucks – companies few investors or traders had ever heard of a decade or two ago.

The NYSE, for its part, dismisses Nasdaq's bragging as childish and unfounded. A spokesman noted that a survey conducted by Opinion Research Corporation in Princeton, N. J., shows "exactly the opposite by a wide margin" – that the Big Board is actually better known among investors.

Nasdaq's success is no accident, says a former regulator, who explains how Nasdaq raised fees on listed companies, then plowed much of the added revenues into retention programs.

"Nasdaq smartly put this money into people and programs that gave special attention to their top 100 companies," according to Patrick Healy, former director of financial policy and strategy at the National Association of Securities Dealers.

"That caused these companies to stay with Nasdaq," added Healy, who now runs the Issuer Network a company based in Chevy Chase, Md., that advises companies on what exchange to list.

But although Nasdaq and the NYSE are not going to use the pages to detail this trading civil war, both exchanges are doing their best to outdo each other. For instance, although AOL, Gateway, Nordstrom and Coors were originally with Nasdaq, the NYSE persuaded them to move.

But Nasdaq, which mainly was concerned with playing offense in its first few years as a David, has also learned to protect its gains, persuading Microsoft, Cisco Systems and Intel to stay.

"Those firms could go anytime they want and anywhere they want, but they elected to stay because Nasdaq made an extra effort to keep their business," Healy added. This competition was heightened last year with the end of Rule 500, which practically chained and bound companies that were with the Big Board. No more.

Last year, after the demise of the rule, Nasdaq reminded companies that listing with an exchange is not like marriage in a country without divorce laws.

"Nasdaq," according to John Tognino, executive vice president, global sales and member affairs for Nasdaq, "began a concerted campaign to make sure that every company, whether it was on the Nasdaq or the NYSE, had the true option of picking the marketplace that was in their best interest."

Once again, the pushy exchange's efforts paid immediate dividends. Aeroflex (Nasdaq: ARXX) moved from the NYSE to Nasdaq. Nasdaq is also pushing to outflank the Big Board outside of the U.S.

Nasdaq's goal is to "be able to say when you list with Nasdaq, you list with the world," Frank Zarb, chairman and chief executive of the NASD, said in a speech last summer. "Your investor pool will have no national boundary, your liquidity will grow in a significant way, your brand will be shown in stock tables in many different languages."

Madoff says that Nasdaq's digital advantages make it attractive in Europe. "The dealer marketplace is something that Europeans now understand. The rest of the world looks at Nasdaq as a very advanced, high-tech market that's well suited for the future," he added.

Indeed, Nasdaq was considered in the running to takeover the London Stock Exchange after the collapse of its merger with Deutsche Borse. (Nasdaq had an earlier deal with London and Deutsche Borse to run an advanced electronic market in Frankfurt.)

Across the globe, Nasdaq is forming alliances and is in talks. "Two years ago not many people [in London] ever heard of Nasdaq," said Mark McCutchenson, head trader at Greig Middleton, a brokerage firm in London. Now it is fast becoming a household name in London, he added.

Tognino said it recently reduced spending on advertising in the U.K. But that was for good cause. "We began to get the story out that Nasdaq is a global market," he said.

In the U.S., NASD spending on advertising and marketing grew from $47 million in 1998 to about $70 million last year. In the first half of this year, spending on advertising climbed to $15.4 million, compared with $5.7 million in the same period last year, according to Competitive Media Reporting, a New York-based firm that tracks advertising spending.

Nasdaq is once again comfortable enough to tout its own horn, both in print and on television. "Nasdaq is the Stock Market For a Digital World," says the line in its current campaign created by New York-based advertising agency, Messner Vetere Berger McNamee Schmetterer/Euro RSCG.

Only a while ago, Nasdaq was embarrassed by an earlier campaign with the memorable line, "The Stock Market For the Next 100 Years." The Nasdaq price-fixing scandal did not quite fit that image.

Nasdaq, as of mid-September, listed some 480 non-U.S. companies with a market capitalization of about $1 trillion, according to a Nasdaq spokesman. He adds that, so far this year, the exchange has added 89 non-U.S. companies. Nasdaq's overall capitalization is now some $5 trillion plus.

But it isn't all beer and skittles for Nasdaq's success. In its battle for supremacy, it has made some enemies. Its push to expand through demutualization has bred a group of critics who contend it is the cat's-paw of a few big firms.

"Their market is focused on large issuers, primarily the New York Stock Exchange large issuers. They are not focused at all on small or medium companies," said Alan Davidson, president of Zeus Securities in Smithtown, N. Y.

The war between the NYSE and Nasdaq – declared or otherwise – must stop, he says.

"This conflict between the NYSE and Nasdaq is really counter-productive. Because members of the NASD are members of the NYSE and members of the NYSE are members of the NASD," Davidson said.

Will the lions and lambs lie down together anytime soon? Not likely. There's every indication that Nasdaq, along with a dot.com economy that is here to stay, is going to continue to push and that NYSE officials are going to have to rethink their place in the trading universe. The battle has been going on for three decades, but the intense, mano-a-mano, combat has just begun, some observers say.

It's a risky play. But several Wall Street dealers say they are coming through for their institutional clients, even in the face of abysmally low trading volume.

They are putting up the capital required by clients to get block trades done.

Committing capital means that, rather than look for a buyer of the customer's stock, a dealer buys the stock itself.

Usually, the firm steps in, because there is a glut of sellers in the market. A buyer at an acceptable price cannot be found.

So the firm offers the customer a better price than it could fetch in the market, often taking a loss for doing so.

The reason for doing this, explained Scott Saber, executive director of equities at UBS Warburg, is to preserve the relationship with the customer.

Important Clients

In fact, one of the criteria in determining whether a firm will put up its own money for a trade is how important the client is to the firm, whether it is a mutual fund or a pension fund.

Saber said that capital commitment has increased at many Wall Street firms, even though their risk tolerance for doing so may differ.

Jon Olesky, head of block trading at Morgan Stanley Dean Witter, says the great capital commitment trend has increased this year.

"The business has naturally evolved to a higher level of capital commitment," he said.

While trading volume has been low in recent weeks, overall stock market volume is up 25 percent to 35 percent in the past year, Olesky explained. Trade sizes and share volume have increased.

One trading house executive cautioned that risking more capital in the current volatile market conditions is foolish.

Peter DaPuzzo, co-president of institutional equity sales and trading at Cantor Fitzgerald, said his firm will always put up capital when it is required to get a trade started.

But sometimes it is better to make more calls in search of the other side. "The losses per share [from putting up too much capital] are severe if you are wrong," he said. "The volatility can hurt."

Traders said that Wall Street's big selling point, in a field of upstart trading systems and electronic brokerages, is that its pockets are deep enough to put up cash for a customer when the entire market is against the trade.

Mutual fund traders note a movement toward using small independent trading firms more frequently than ever before, as a way of cloaking their trading strategies.

Mutual funds complain that some trades placed with Wall Street's bulge-bracket firms receive inferior prices, because information is leaked to the general marketplace.

To prevent this, some mutual funds try to conceal orders through low-profile trading shops, some of which also execute orders for hedge funds or extremely wealthy individuals.

To this end, Jamie Atwell, head of trading at Nicholas-Applegate Capital Management, said he works with at least one such trading shop. He declined to name the firm.

Olesky declined to comment on specific instances of capital commitment. John Peluso, head of block trading at Lehman Brothers, also declined to comment-as did an official at Goldman Sachs-citing the sensitive nature of information about the firm's risk portfolios.

Jim Toes, a director of Nasdaq trading at Merrill Lynch, said the firm is always competitive. "As far as any changes go, our customers are always demanding capital," he said.

Reducing Broker List

Meanwhile, there has been a steady move on the buyside toward paring the number of brokers it uses, to ensure better service from fewer firms.

Buy-side traders claim they are doing this mainly so that they can rely on capital commitment at critical times.

By keeping their roster of brokerages small, buy-side traders can send more commission dollars to the firms with which they opt to work. with staff reports

If there were Olympic gold medals handed out for longevity, tenacity, and generosity on Wall Street, Alan Ace' Greenberg would have a roomful.

At 73, Greenberg, the colorful chairman of Bear, Stearns & Co., still works the trading floor. He is easy to spot. Greenberg is the husky, bald-headed guy with his shirtsleeves rolled up, smoking a Macanudo cigar, barking out orders like a five-star general.

Greenberg, who often speaks in a monosyllabic conversational style, said trading is like a game. "I do it for the same reason I play golf or bridge. I enjoy it," he said. "Even when the markets are down." (On the day this reporter visited Bear Stearns the Dow Jones Industrial Average was off 184 points.)

Prize View

Like many top Wall Street movers and shakers, Greenberg has a plush, executive suite with a fantastic view. But he hardly ever uses it. "I find being in an office very isolating," he said. "I like hearing people talk and waving to people as they go by." The veteran trader shouts out across the floor to a fellow trader, "Anything going on?"

Greenberg takes great pride in how easy it is to get in touch with the chairman of one of Wall Street's premier firms. "People do not have to call my secretary for an appointment," he said as he swiftly fielded one of the many incoming phone calls. Greenberg calls out to his executive assistant, Laura Schreiner, "Do they ever call you for an appointment?" She instantly fires back, "Never."

Born in Wichita, Kansas and raised in Oklahoma City, the son of the owner of a women's clothing store chain, Greenberg once dreamed of dashing across a football field rather than commanding a large trading and investment banking firm.

Upon graduating from high school in 1945, he attended the University of Oklahoma on a football scholarship. But while playing as a halfback in a game during his freshman year, Greenberg suffered a back injury. That put an end to his football career. A year later, in 1946, Greenberg transferred to the University of Missouri, where he received a bachelor's degree in business.

He gained the name Ace' during his college days. Greenberg confided to his good friend and then roommate, Alvin H. Einbender, who later became a chief operating officer at Bear Stearns, that he was having difficulty in getting dates. Einbender suggested that Greenberg change his name to Ace' Gainsboro. The nickname, Ace, stuck but Gainsboro was quickly scrapped.

Oklahoma Departure

Upon graduation in 1949, Greenberg moved from Oklahoma City to New York to start out his career on Wall Street. "I was a little too close to home," Greenberg recalled. "I wanted to go farther away. I wanted to become a success."

The 21-year-old, transplanted Mid-westerner landed a job as a clerk at Bear Stearns in the firm's oil and gas department. His salary was $32.50 a week. Four years later, at the age of 25, Greenberg was running the firm's arbitrage desk. In 1978, he was named chief executive.

He credits his rapid rise to more experienced traders who took him under their wing. "I worked for some people that were willing to give me plenty of leeway," Greenberg said. "They didn't always agree on what I should make, but they came around. They didn't exactly throw the money at me."

Life has not been all wine and roses for Ace. At 31, he was struck with colon cancer. Back then there was no chemotherapy or the kind of life-saving treatments that are available today. Greenberg had only a 25 percent chance for survival. He underwent surgery and beat the incredible odds. "I was lucky," he reflected. "I am still here."

While many top-tier, investment banking firms only hire freshly-minted MBAs from mostly Ivy League schools, Ace is more interested in a candidate's drive, ambition, and street smarts.

In one of his famed interoffice memos, which was collected in the book, "Memos From The Chairman" (Crown, 1996), he wrote, "If somebody applies for a job with an MBA degree, we will certainly not hold it against them. But we are really looking for people with PSD degrees. PSD stands for poor, smart, and a deep desire to become rich."

Fat Reward

As a top executive at one of the Street's most successful firms, Greenberg is handsomely rewarded each year with a bonus check that's in the many millions. He also gives away millions. In 1992, he sold off a large portion of his Bear Stearns stock for $7.8 million and donated most of it to charities.

Greenberg has been honored by a slew of organizations for his charitable efforts, including the NAACP, the Israel Bond Organization in New York, the Jewish Foundation for the Righteous, and the Federation of Jewish Philanthropies. He is a shining example for Bear Stearns' senior managing directors who are required to give four percent of their salaries to charitable causes.

"In almost every case they [the managing directors] give more than four percent," Greenberg said. "They get involved in local hospitals, libraries and schools. It's certainly worked out for the charities and the people at Bear Stearns."

Greenberg abhors waste as much as he is committed to giving money away to worthy causes. He is known for keeping close tabs on every penny that is spent at Bear Stearns. Greenberg once instructed employees to save paper clips rather than buy new ones.

In one of his legendary, cost-saving memos, he wrote, "I have just informed the purchasing department that they should no longer purchase paper clips. All of us receive documents every day with paper clips on them. If we save these paper clips, we will not only have enough for our own use, but we will also, in a short time, be awash in the little critters."

Over the past 50 years, Greenberg has witnessed a remarkable number of changes on the Street – from consolidation and computerization to the advent of Nasdaq and ECNs. Despite these sweeping transformations, he feels that the nuts and bolts of trading still remain the same.

"Trading is a profession with virtually no shades of gray," Greenberg wrote in the forward to Abe Rubenfeld's "The Super Traders" (Probus, 1992). "At the end of each day, your performance is there in black and white for everyone to see. Did you hold that position a day, an hour, or even a minute too long, irrationally hoping that the price might miraculously turn in your favor? Did you act on some impulsive thought or unsubstantiated rumor, only to see it blow up in your face? If so, there's no hiding the results or shifting the blame; it's all there, counted to the penny. Make no mistake about it – trading is a ruthless profession."

In recent years there has been much hoopla about 24 hour, global trading. Greenberg thinks the prospects for around-the-clock buying and selling is more sizzle than steak. "It hasn't worked so far," he said. "Keep in mind that Twenty-One is not open for breakfast, but it's a pretty good restaurant. They do nice business when they are open for lunch and dinner. I don't know what rule says you have to be open to trade 24 hours a day."

Acquisition Target

Bear Stearns is one of the few remaining independent trading and investment banking firms. A report issued earlier this year by a Salomon Smith Barney analyst indicated that the firm's chief executive officer, James Jimmy' Cayne, may wish to follow in PaineWebber's footsteps. (UBS Warburg is acquiring PaineWebber). The report mentioned that Cayne would consider selling out for four times the firm's book value, which is currently about $120 a share, or $18.9 billion. To this speculation, since quieted down, about the possible sale of Bear Stearns, Greenberg coolly said, "no comment."

This past September, Greenberg turned 73. When asked if he had any plans to retire or reduce the number of hours he spends on the trading desk, he playfully replied, "I do plan to die some day. I definitely plan to die. But I haven't picked a time yet."

For the young trader who is starting out, Greenberg said he gives the same advice he gives to any young person. "Get a job that you are happy with and one you can look forward going to everyday. You shouldn't work 15 or 20 hours a day. But you should enjoy going to work and enjoy going home."

As the New York Stock Exchange prepares to launch Institutional XPress, the early indications from the trading community are not positive: the system won't go far enough to give institutions direct access to the floor, some pros say.

At issue is the requirement that an order be exposed to the floor for at least 30 seconds before it becomes "expressable," that is, eligible for remote electronic execution.

"In an electronic world, you don't have time to chat," one mutual fund trader said, let alone expect to be able to wait 30 seconds on an order without having the market move unfavorably, he added.

The system aims to give traders not located on the NYSE floor access in two ways: by displaying quotes on the specialist's book and by providing order execution as long as the NYSE's floor traders have been able to see the order for 30 seconds.

An NYSE spokesman emphasized that the system is one way for institutions to participate in the market.

By sending orders to a broker's hand-held' electronic device, institutions get access instantaneously, the spokesman said.

The information phase of the system went live in June. The system's trading phase is due out before the end of the year.

The buy-side community-mutual fund traders particularly-has been clamoring for direct access to the NYSE floor for years, arguing that being kept in the dark about floor action has put it at a huge disadvantage.

Floor traders, for instance, make decisions about pricing their orders based on where large institutional orders coming to the exchange are priced.

The institutions, on the other hand, are not provided the same information and risk having their orders quoted outside the spread and left unexecuted.

Institutional XPress may be a misnomer. The system will be available to any trader on the buyside or the sellside, as long as he is not located on the exchange floor.

The system also will require orders to be quoted at a minimum of 25,000 shares to be eligible, a requirement the Investment Company Institute in Washington claims is too rigid.

In a comment letter, the ICI pointed out that many institutional orders in small-cap stocks are below the 25,000-share level and will not receive the benefits of the system.

Despite its shortcomings, the system breaks some ground in opening information to big players not physically located at the NYSE, the ICI official and traders said. And it may help to further a trend on the buyside to behave more like a dealer and cut out the broker.

Separately, in another example of how technology is allowing the exchange to provide more direct services for customers is a move by independent floor brokers toward direct interaction with buy-side clients.

Independent brokers traditionally have made their living executing overflow orders farmed out to them by the large brokerage houses.

But Larry Helfant of Lawrence Helfant Inc., a large independent broker on the NYSE floor, said he has several buy-side clients from whom he receives orders directly, via a few dedicated terminals installed in his booths on the floor.

Helfant said dealing directly with the buyside is more lucrative than dealing indirectly via large brokerages. That's because the floor broker does not have to share the commission with the big brokerage house farming out the order.

One hurdle for firms such as Helfant's is gaining name recognition with the institutions. Most of these firms do not employ marketing teams, nor do they operate retail brokerages with widely recognized brands, Helfant said. In addition, he said, small independent brokers face capital and clearing requirements.

The NYSE is setting out to convince Wall Street and the public that it provides the best execution of any market.

The NYSE has released a working paper that explores a different measure of best execution: depth improvement.

Instead of price improvement, which means that an order gets executed at a price that is better than the national best bid or offer (NBBO), depth execution means that the institution is able to execute more shares than what's quoted at the NBBO.

Suppose an institution places an order to buy 5,000 shares, even though the best offer is for 3,000 shares. If the institution is able to get all 5,000 shares executed at the best offer price-due to dealings among specialists and traders-then the institution receives depth improvement.

"We are very keen on this measure and pushing it because we're concerned that penny spreads will reduce the depth of the quote," said George Sofianos, chief economist at the NYSE.

The exchange plans to meet with member firms and the Securities and Exchange Commission to discuss the validity of depth improvement as a measure of execution quality.

While the NYSE says that approximately 40 percent of all market orders receive price improvement at the exchange, its recent working paper claims that nearly 70 percent of all such orders achieve depth improvement at the NYSE.

What does this ultimately mean? The exchange suggests this depth measure should be factored into an assessment of price improvement, called adjusted price improvement. Take again the institutional order of 5,000 shares. Suppose the best offer is for 3,000 shares at 20. The institution may have to execute the remaining 2,000 shares at, say, 20 1/16. The volume-weighted price of the order is 20 1/40.

But suppose the institution gets more shares executed at the best price. If 4,000 shares, rather than 3,000, are executed at 20, and the remaining 1,000 shares are executed at 20 1/16, then the volume-weighted price of the order falls to 20 1/80, instead of 20 1/40. This provides a more accurate measure of best execution, the exchange argues.

Tim Heekin, head of trading at Thomas Weisel Partners in San Francisco, pointed out, however, that in today's market, traders have to assess prices available on competing private systems.

"Volume-weighted price doesn't encompass everything," Heekin said. "This market's gotten very fragmented, and you have to be cognizant of other trading opportunities out there."

The revolutionary system will transform Nasdaq into a super electronic communications network. And not everyone is pleased.

After about 12 months of debate, seven amendments, and four extended comment periods, most securities industry participants who aren't ardent supporters of Nasdaq's supermontage proposal have at least resigned themselves to it.

SEC spokespeople said there was no deadline for a final decision on the supermontage.

Nasdaq is not shy about its ambitions for the system.

"The supermontage provides the ability for the 450 [active] market-making firms to display their customer limit orders under the SEC order handling rules in alternative ways than they can at present," said Alfred R. Berkeley III, vice chairman of the Nasdaq Stock Market, in a recent statement. "The ECNs are going to have 450 new competitors."

Berkeley added, "We have come to a set of solutions that are very pro-competitive for the investor, that have support from the vast majority of buy-side firms, individual investors, and brokerages."

But not all industry participants agree.

"The supermontage is a sort of a back-door, sly way of undercutting ECNs," said John J. Wheeler, manager of equity trading at American Century Investment Management, in Kansas City, Mo. "We are always forced to choose between equal standing and anonymity."

With the supermontage, Wheeler said, "it appears that the NASD is heading in the same direction" as the NYSE, by listing orders from Nasdaq members and regional exchanges first. "We view that as a huge disadvantage to our shareholders," he added.

The supermontage will collect the market orders and marketable limit orders of market makers, ECNs, UTP specialists and order entry firms and match them against the bids and offers displayed in a so-called Order Display Facility.

Market participants will no longer send their orders directly to one another. Instead, Nasdaq will operate as a sort of gatekeeper, controlling the flow and execution of orders. All orders will be matched on price and time priority.

Features include automatic execution; display of the three best price levels instead of just one; trades of up to 999,999 shares; and the ability of participants to display agency and anonymous orders.

Nasdaq Stands Firm

Berkeley, countering claims that the supermontage will transform Nasdaq into a monopolist, said that if the assertions of "two or three ECNs" are examined closely, the truth is revealed.

These ECNs, he contended, have "an oligopoly position because of a quirk in the order handling rules that often cause market makers to send limit orders to ECNs."

That's at the heart of the issue. Nasdaq is "trying to open up limit orders to competition," Berkeley said.

Nasdaq claims it has acceded to many ECN concerns, so far posting seven amendments to its original, November 1999, proposal. One of the latest would give ECN orders the same place in the order processing queue as participants who don't charge a fee, providing the ECN either includes its fee in its quote, or the ECN tells Nasdaq that the price improvement offered by the displayed quote exceeds the hidden quote access fee the ECN charges.

Another amendment would give investors the opportunity to direct or preference certain orders to particular market makers or ECNs, providing the market maker or ECN agrees to accept those orders through a directed order process.

We have found that the success of a commission recapture program is enhanced when the broker, consultant and investment manager work together to serve their common client -the investor.

Commission recapture is institutional discount brokerage. It works by returning commission dollars directly to the investment end-user – the pension plan or fund that ultimately pays the commission. And that reduces transaction costs.

Institutional investors may be more familiar with commission subsidies or rebates in the form of soft dollars.

Soft dollars are portions of broker commissions used by investment managers to pay for research supplied by the broker, whether the research is proprietary or produced by an independent third party research provider.

Commission recapture redirects control over a fund's commissions to the beneficial owner of the pension plan or fund. Thus, simply stated, commission recapture unbundles commissions, separating the implicit research charge – the soft dollar component of the commission – from the execution charge. That charge is then returned directly to the investor that paid it in the first place.

In a typical commission recapture program, a fund directs its investment managers to execute a portion of its trading on behalf of that fund through a specific recapture brokerage firm.

The managers pay their standard negotiated commission rates. The broker then rebates an agreed upon part of the commission back to the fund. The rebate to the fund can be in cash or in payment for the fund's administrative expenses, which may include actuarial fees, accounting expenses or consulting fees. This simplicity of implementation is one reason commission recapture is becoming so popular.

Commission recapture assumes that the recapture broker is competitive in execution and price. As noted, recapture programs are typically based on investment managers' standard negotiated commission rates. Quality of execution can be measured by independent transaction cost monitoring agencies.

For instance, recent reviews by leading agencies like Plexus Group, Abel/Noser and Elkins McSherry rated Instinet first or second in (low) execution cost, not only among peers but compared to full-service brokers as well. A major attraction of commission recapture is that it is consistent with fiduciary obligation. In 1986, the U.S. Department of Labor, which administers ERISA, noted that commissions are assets of a pension plan, and plan sponsors have a fiduciary responsibility to monitor and control them.

The Labor Department reinforced this view in a 1997 study, when an advisory committee noted that "a properly structured commission recapture program can assist investment managers, reduce plan costs and help plan sponsors [trustees] fulfill their fiduciary responsibilities."

The Association for Investment Management and Research has addressed the issue from the investment manager's point of view. It noted in a 1997 report that "because brokerage is an asset of the client, not the investment manager, the practice of client-directed brokerage does not per se violate any investment manager duty."

Consultants should carefully examine competing recapture brokers to determine that they meet the highest standards.

* They should provide best execution on a global scale.

* They should be able to recapture in fixed income as well as equity markets.

* They should provide superior reporting and reconciliation services to spare the client administrative burdens.

* They should offer recapture and discount brokerage services in portfolio transitions as well as in ongoing trading.

Investment managers need to be sensitive to their clients' recapture preferences and their directed brokerage instructions. They should work closely with the broker to establish the recapture program and determine how trades for recapture credit will be identified and accounted for. The broker and investment manager will frequently need to exchange information to determine that the client's recapture targets are met.

Howard J. Schwartz is chairman and chief executive officer of New York-based Lynch, Jones & Ryan, Inc., a wholly-owned subsidiary of Instinet Corporation.

Stephen W. O'Neil was born with trading in his genes. His father, Don, was an over-the-counter trader, and both of his uncles were also traders. As a youngster and later as a college student he was fascinated with Wall Street and trading equities.

"I'd be in the office and watching them trade," O'Neil recalled. "It always seemed like a very exciting business with a lot of action and a lot of money being thrown around. That always made it real interesting to me."

O'Neil's family tree also has strong roots in the Security Traders Association. His uncle Bert was the founder and first president of the STA of Los Angeles (STALA) when it began in 1935. His other uncle, Dick, was STALA president in the mid-1950s. Today, his son, Tim, is keeping up the O'Neil family tradition. He is a sales trader at Jones & Associates in Fort Worth, Texas.

Born and raised in Los Angeles, Stephen O'Neil, head trader at Mitchell Hutchins Asset Management and the incoming chairman of the Security Traders Association, is a tall, thin and handsome figure who could easily be cast as a leading man in a Hollywood movie.

Early Career

O'Neil started his trading career while attending the University of Southern California. In 1964, he took off a year from college to work at Blyth & Co. in Los Angeles, which at the time was one of the largest OTC trading firms.

Like many aspiring OTC traders, O'Neil learned the ropes of the business by doing basic chores. Back in the 1960s, OTC trading desks were far from computerized like they are today. Stock quotes were listed on chalk boards. O'Neil's job was to mark up the boards with the latest quotes.

"In those days they used telegraph machines," O'Neil recalled. "Most of the markets were made in New York, but they would telegraph the quote changes during the day and you would mark the board."

After spending a year soaking in the OTC trading environment, O'Neil knew exactly what he was going to do after graduation – follow in his father's footsteps and become a full-fledged trader. Upon earning a degree in business administration from USC in 1969, he returned to the OTC trading desk at Blyth & Co. This time he was no longer marking up the chalk board, but buying and selling OTC stocks.

Shortly after Nasdaq was created in 1971, O'Neil moved over to the institutional sales side after Blyth & Co. became Blyth Eastman Dillon & Co. through a merger. "I thought moving into the institutional area would be a good move," O'Neil said. "It turned out to be a good move because that was when institutions were really starting to take hold."

Then in 1975, O'Neil made another big switch. He became a buy-side equity and bond trader in the trust department at Lloyds Bank in Los Angeles. "It was an interesting spot," O'Neil said. "I was not only trading equities, but I was also trading municipal bonds and cash [money market funds]."

Four years later, in 1979, he landed a top post as senior equity trader at ARCO Investment Management Co. O'Neil was charged with handling trades for the company's pension fund, which had assets of about 1.5 billion dollars.

Two years ago, O'Neil left Los Angeles to become senior vice president of equity trading for Mitchell Hutchins Asset Management, the mutual fund and financial asset arm of PaineWebber, in New York. The trading desk comprises three traders, including O'Neil, and handles transactions for about $7 billion in equity assets.

"Working at Mitchell Hutchins is a round-trip for me in a way," O'Neil said. "I started out at Blyth & Co. and PaineWebber had bought Blyth Eastman Dillon."

O'Neil believes in giving something back to the trading community. His involvement with the STA began in 1987, when the then president of the STA, Arthur Rowsell, asked him to chair the organization's institutional advisory committee, a post which he currently holds. O'Neil has been an officer and director of the STALA and the same as his two uncles, served as its president. A chartered financial analyst, O'Neil is also director of the National Organization of Investment Professionals and a member of Nasdaq's Institution Traders Advisory Committee.

Buyside Leadership

This year marks only the second time a buy-side trader has become chairman of the STA. (The first buy-side trader to chair the STA was Austin George of T. Rowe Price). O'Neil plans to draw upon his vast buy-side trading background to foster greater involvement in the STA from the buyside. He pointed out that the buyside is more involved with the New York Stock Exchange and Nasdaq than it is with the STA.

Unlike the NYSE or Nasdaq advisory committees, noted O'Neil, the STA is an association at liberty to publicly comment on market issues to regulators and lawmakers, including the Securities and Exchange Commission and the National Association of Securities Dealers.

"Unfortunately," O'Neil said, "the involvement of the institutional trader hasn't been as good as it should be with the STA." His top goal as chairman of the STA is to reach out to the buyside to participate in various STA committees and activities.

Robert C. King, the current chairman of the STA and head of Nasdaq and OTC trading at Robinson Humphrey in Atlanta, said O'Neil's experience on the buyside "will be very beneficial for the association and its membership." He added, "Steve's insights will be refreshing and good for the organization."

Although the buyside comprises a small part of the national STA membership, O'Neil said, it does play a large role in many of the organization's local affiliates, such as Chicago, Los Angeles, and San Francisco. "I'd like to see the buy-side representation increase on the national level," he said.

According to O'Neil, the institutional buy-side trading community is fragmented. "They don't have one place to come together," he said. "The STA is a way for them to do that."

STA Critic

Last year Harold Bradley, a former head trader and now president of American Century Ventures at American Century in Kansas City, said that "the buyside should think about dropping out of the STA. We can't get our ideas through. The STA is a sell-side organization."

To this scorching criticism of the STA, O'Neil responded that the STA is very active in projecting its views to the regulators in Washington. "STA has the mechanics in place to do that," he said. "If the buyside were to form its own organization from scratch, that would be a tough battle."

But O'Neil does agree somewhat with Bradley's observation that buy-side traders do not have an organization that caters exclusively to their concerns. The incoming chairman is determined to dramatically improve the disconnect between the buyside and the STA.

How does O'Neil plan to enlist greater participation from the buyside? "Lee Korins [president and chief executive of the STA] and I are going to knock on some doors," he said. Also, like a sophisticated politician, O'Neil plans to undertake a national listening tour. "I am going to find out why the STA does not seem to be important to the buyside," he said. "I am going to listen to the buyside and then figure out what the STA can do to change their perceptions."

O'Neil's background as a buy-side trader, said Korins, will undoubtedly bring a different perspective to the organization. "While the buyside and sellside may be antagonistic at times to each other during the trading day," Korins said, "the interests of both [groups] are not that dissimilar. They both want strong marketplaces. Because without strong marketplaces neither one of them can function effectively."

Alice Davis, who was the first woman president of the Security Traders Association of New York (STANY) in 1992 and is currently a sales trader at Prudential Securities, echoes Korins sentiments: The sellside and buyside have a lot more in common than major differences. "I think we [sell side and buyside] have become much more in tune with one another and we all want the same things," she said. "I think Steve will help bring that along."

One year from now, O'Neil said, he would like to see every institutional buyside trader involved with STA through their local affiliates. "And I would like the ones who want to become more involved," he added, "to participate in a committee made up of just buy-side traders."

O'Neil believes there will always be differences of opinion between the buyside and the sellside. For example, he indicated that institutional traders are for the most part in favor of implementing a central limit order book, while the dealer community is generally opposed to this type of centralized market structure.

Big Tent

Despite the differences between the buyside and the sellside, O'Neil said, the STA is a big enough organization that can encompass all points of view. These disparate views can be expressed through the STA's various committees. "This is the only association I know that has a lot of history and can be used to get to these people [regulators] together," O'Neil said. "The SEC and the NASD certainly know of the Security Traders Association."

He added that legislative people are also becoming more aware of the STA. O'Neil cited the STA as instrumental in bringing to the forefront the controversial issue relating to Section 31 transaction fees (a tax of three-hundredths of one percent of the sale price of stock)."It's been a long agonizing battle," he said. "The SEC is making millions of dollars from these fees." The SEC's annual budget is $370 million, but it collects subtantially more than that from Section 31 fees. O'Neil pointed out that individual dealers do not have the wherewithal to undertake this fight. "If it [Section 31 fees] gets reduced," O'Neil observed, "it will be because of the STA."

Besides focusing on enlisting greater involvement from the buyside, O'Neil also plans to reach out across the 49th parallel to Canadian traders. "I'd like to get more interchange about market structure issues from Canadian traders," he said.

As far as market structure in the U.S., O'Neil foresees the move to decimalization will be as huge as the demise of fixed commissions in 1975. "Volume is going to become much larger," he predicted. "Institutional traders may have to change the way they handle their orders because people can step ahead of them for a penny."

The question for institutional traders, O'Neil suggested, is how are they going to expose their orders and how much of their orders are they willing to expose in this penny-conscious environment. If institutional traders are less willing to disclose their orders, he asked, what does that do to transparency and liquidity? "Anonymity of orders will become more and more important," O'Neil emphasized. "An institution will most likely be more comfortable exposing a big order to an ECN rather than going to the floor."

Like negotiated commissions, O'Neil is convinced that the Street will eventually work out all of the bugs that emanate from decimalization. The big unknown, he noted, is precisely how buyside and sellside firms will cope with these momentous changes that will inevitably alter market structure.

O'Neil and his wife, Julia, both transplanted Angelenos, who are accustomed to basking in the California sunshine, have had no problem in adjusting to the hustle and bustle of the Big Apple. "I love New York," he said. "In Los Angeles I commuted by car all my life. Now, I walk to work and walk home."

Stephen W. O'Neil is senior vice president and head trader at Mitchell Hutchins Asset Manaagement, the mutual fund and financial asset arm of PaineWebber.

He and his wife, Julia, live in the heart of Murray Hill in New York City. They have three children – Tim, 32; Brian, 29; and Denna, 21.

O'Neil is chairman of STA's Affiliate Liason and Institutional Committees, vice chairman of its Trading Issues Committee and a member of its Executive and PAC Advisory Committees. He has been an officer and director of the Security Traders Association of Los Angeles and served as its president in 1990. He is also a director and secretary of the National Organization of Investment Professionals.

For fun and relaxation, O'Neil recently took up golf. Both his wife and three children are expert golfers. "I am not that good at it," he quipped, "but I promised my wife that I would work harder on improving my game."

When O'Neil lived in Los Angeles he was an avid bike rider, body surfer, and swimmer. "That's one thing I miss about California," O'Neil said. "But here in New York I can walk to work and walk home."

Lupien got it wrong.

Will Merrin get it right?

Seth Merrin, the technology pioneer widely credited with launching the order management system industry, is now vowing to do what others tried but failed at: eliminate market impact on block trades.

Merrin's new venture, Liquidnet, hopes to provide access in one gigantic pool of orders, the liquidity in the OMSs at the top buy-side firms.

The plan: Traders using Liquidnet will be electronically notified when the system has the other sides of orders on their blotters. The traders would then have the option of negotiating the trades with their counterparties.

"We are creating a country club kind of network," said Merrin, chief executive of Liquidnet, a 30-person operation based in New York. "All the members have the same problem-huge orders they must execute."

"The market impact is killing them because right now brokers are the only way they know to match up with other institutions," he added. "Market impact is an enormous problem."

Merrin had a hit ten years ago when he introduced the Merrin Financial Trading Platform (now owned by The MacGregor Group). Since then the installed base of these order-tracking and routing devices has ballooned to some 700. All told, they account for an estimated one billion shares in order flow each day, according to the Tower Group, a securities consulting group in Needham, Mass.

Traders agree that market impact, or the effect of a large trade on the price of a stock, is a costly overhead. But while they like the Liquidnet concept, some foresee practical problems in using it. "They say it's a passive system, but in practice the trader is going to have to make adjustments everyday on his OMS, or else he is going to run into problems," said one trader familiar with Liquidnet.

The Liquidnet scheme has three parts. First, it plugs into the OMSs of the largest trading desks over the Internet and amalgamates all the orders. Second, it displays to traders select contra-orders to those in their OMSs. Finally, it lets traders negotiate price and quantity among themselves via text chat. No sales traders are involved so no information is leaked, Merrin says. That eliminates the possibility of market impact, he says.

Unlike other trading systems, there is no inputting or monitoring of orders. Finding the other side is a completely passive process on Liquidnet. Liquidity is brought to the trader. The trader does not have to bring liquidity to the system.

Traders never know with whom they are dealing. They also do not know the total amount of the stock available for sale. They only know there is enough to at least match a predetermined minimum portion of their order.

Minimum quantities negotiated are based on parameters established by traders when they first connect to the system. A trader might specify he will only accept contras with at least 25 percent of his order. That way a buyer of one million shares, for example, would be dealing with a seller of at least 250,000 shares, if at all. (A million-share buyer would normally not want to deal with a 5,000-share seller.)

Liquidnet is only courting the largest institutions with OMSs. It says 134 have indicated an interest. Launching in December, it will not charge "members" a license fee for the technology. As a broker dealer and Securities and Exchange Commission-registered alternative trading system it will charge a pennies per-share fee on each transaction.

On its board of advisors are the head traders of Aim Advisors, Scudder Kemper Investments, Putnam Investments and T. Rowe Price.

"It holds great promise," said Leo Smith, Putnam's head trader. "It takes the promise of OptiMark and makes it easier. Ultimately it will be successful."

Smith notes that too many traders settle for the VWAP, or the volume-weighted average price of a stock over the course of the day, when transacting. "This will force people to make decisions. We're supposed to be traders, not VWAPers."

Like all other traders interviewed for this story he does not believe Liquidnet will completely replace the sales trader. "I look at it as another avenue to source liquidity," he said. "It's not totally doing away with anything."

Liquidnet is not the first piece of technology to tackle market impact. Three systems aimed at block-traders have come and (mostly) gone over the years.

OptiMark Technologies, founded by Bill Lupien, was a multi-million dollar failure now partly on the auction block. @Harborside, an indications service, was yanked from the market by parent Jefferies after only six months in service. (Creator Richard Holway says it will be available again soon following some enhancements.) The Arizona Stock Exchange, a call auction system near death earlier this year, won a stay of execution when Goldman Sachs took a stake. All three suffered from a lack of liquidity.

Traders give various reasons for the failures including questionable anonymity, difficulty of use, time-consumption, and too many "nothing-dones." Merrin says Liquidnet avoids the first three problems and shifts the burden of the fourth to the trader.

Nothing-dones aren't likely to completely disappear, however, because a trader is under no obligation to trade. "They're not committed orders," Merrin acknowledged. "They're only indications really."

"Indications" in the strictest sense are those sellside-to-buyside e-mails suggesting trades. They have come in for criticism as brokers posting indications are often just "fishing," or trying to gauge the market with no intention to follow through. Thomson Financial's AutEx and Bridge are the two biggest operators of IOI networks.

The slippery nature of the "orders" concerned Kevin Cronin, head trader at AIM, at first. "That was one of the things I worked hard on," said Cronin, an adviser to Liquidnet. "We want to make sure the people in this system are people who really want to trade."

The system will monitor and score traders' accounts based on how often they negotiate. Other traders will be able to use those scores to determine the seriousness of a contra. If a trader frequently refuses to negotiate his rights will be revoked, according to Cronin.

"These are not just brokers fishing," he said. "[With Liquidnet] you can start the negotiation process with a guy because he says he's looking for exactly what you have."

Another trader predicts the rating will hurt "good" traders. They will get black marks from contras for not matching orders they consider unexecutable, but in the blotter anyway. He cites three examples. First, a user transacts over the phone while his order is still in Liquidnet. An angry contra watches a print go up and gives the trader a black mark.

Second, the trader is unwilling to negotiate an order on the blotter at current prices. Again, the contra complains. Third, the trader refuses to negotiate an order filled but not yet deleted from the OMS. Some buy-side shops don't clear out their OMSs until the end of the day when they allocate.

"Guys are going to have to start marking the orders they want to go into the system and those they don't," the trader said. "Once you get to that point what happens to the promised ease of use'?"

On the flip side, Liquidnet appears to solve problems traders had with OptiMark and @Harborside. Because it allows them to see some size they are not flying blind as with OptiMark, or "OptiDark" as it was uncharitably called. "OptiMark never really helped us to understand supply and demand," Cronin said.

Because Liquidnet discloses no names it says it guarantees anonymity. Traders were never comfortable with the two sales traders in the middle of an @Harborside transaction.

Middlemen are considered the root of the market impact problem. Sales traders at brokerages leak information that moves prices. Even traders at successful systems like Instinet and Posit are said to leak information. (Officials at Instinet and Posit deny this.)

Liquidnet is, of course, a middleman. And it plans to amass a huge amount of very valuable trading information. Merrin claims it's impenetrable. "Nobody within Liquidnet can see what is going on," he said. The startup hired accountants Ernst & Young to audit its processes and procedures to certify Merrin's claim.

Some traders are still not convinced of the utility of electronic middlemen. Brian Pears, head trader at mid-sized Wells Capital Management, is skeptical that bypassing the sales trader will necessarily result in better performance numbers.

"I'm not sure how much demand there really is for institutions only to be talking to each other," Pears said. "We all talk like that, but I think the buyside relies on the sellside for a lot more than they think they do. Liquidnet is an interesting idea, but it won't revolutionize the trading community. I don't think it will ever gain critical mass to the point where people say this is the way to trade."

Pears says a good sales trader can save him from making a bad trade. If he buys the first 100,000 shares from a seller of 2,000,000, the price he pays may look ridiculous once the remaining 1.9 million hit the Street. His sales trader can forewarn him that the other side may have more to do.

"That's what we would lose in negotiating over text chat with another buy-side trader," he said. "The sales trader is incented to protect their client somewhat."

Pears says he is willing to try the service, but it won't become a regular part of his routine unless it proves itself with liquidity.

Merrin acknowledges his system won't completely replace sales traders, but says the liquidity will be there:

"If we start off on Day One with the 100 largest institutions on the Street," he said, "we're going to have more market information in our system than the exchanges."