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Online Extra: A Pipsqueak Swinging at the Big Board


No one can say Seth Merrin's ideas lack chutzpah. With his latest brainstorm, the 43-year-old New York entrepreneur is mounting an assault on no less than the New York Stock Exchange and the stranglehold it maintains on the trading of its own listed stocks. Merrin's company, Liquidnet, is Wall Street's answer to online dating, matching big buyers and sellers of stock over the Internet. Institutional customers, such as pension funds and mutual funds, cut out the middleman completely by using Liquidnet's messaging system to negotiate trades directly with each other.

This swap-market approach cuts costs to the bone. "The NYSE serves two masters, retail and professional investors," says Merrin. "We only cater to one constituency, the institutional investors, and so we serve them better."

CHEAPER CHARGES. What's working in Merrin's favor is the widespread unhappiness with the Big Board specialist system. Liquidnet's anonymity also holds great appeal for institutions. Sidestepping the exchange and conducting so-called peer-to-peer transactions, argues Merrin, prevent smaller, more nimble traders from buying or selling ahead of the large-block trades that they see in the pipeline, which moves the market and eats away at profits.

Plus, Liquidnet charges just 2 cents a share, while charges for an NYSE trade can be much higher -- commissions average around 4 cents a share but costs can reach 45 cents when delays in executing trades and missed trades are figured in, says Plexus Group, a Los Angeles firm that researches securities transactions.

Of course, Liquidnet is still very much a David to the Big Board's Goliath. It started in April, 2001, and still does barely 1% of the daily volume handled by the NYSE. But its daily average of 19 million shares per day, two-thirds of which are Big Board-listed stocks, was up 113% last year. And the average execution size last year of 41,555 shares is the industry's largest.

Elkins/McSherry, a unit of State Street Co. that provides trade-execution analysis, recognized Liquidnet last year as one of the 10 least-expensive trading venues for NYSE and Nasdaq stocks out of 2,000 brokers worldwide, beating out Wall Street's old-line firms.

HISTORY OF SHAKING. Liquidnet's growth shows no sign of abating. Already, it's capturing a bigger share of the biggest block trades than Wall Street's old-line firms: More than half of Liquidnet's trades each day are the largest trades of the day in a particular stock, according to Plexus. In fact, the NYSE's average trade of a Dow 30 stock is a tad over 1,000 shares, compared with Liquidnet's 76,000 shares. The upstart now has contracts with 251 institutional customers, including T. Rowe Price, AIM Capital Management, and Deutsche Bank, that collectively manage $6 trillion in assets. About 180 are actively trading.

For now, Liquidnet is still a tiny operation. It has a staff of just 97 in Manhattan's Garment District. Merrin has raised $29 million to fund the company, primarily from New York-based TH Lee Venture Partners. Liquidnet broke even in its second quarter in business, Merrin says, and this year expects to post revenues of $100 million. It doesn't disclose profits.

This isn't Merrin's first stab at shaking up Wall Street. As a 22-year-old head risk-arbitrage trader for Oppenheimer & Co. in the mid-1980s -- where "champagne was uncorked every time the market traded at least 100 million shares a day" -- his disdain for paperwork festered. The native New Yorker left Wall Street shortly after and, from the back of his father's ancient-art boutique on Manhattan's Fifth Avenue, hatched a plan to transform manual buy-and-sell orders into an electronic management system.

NET INSIGHT. The idea was revolutionary -- and a tough sell. A complementary automated compliance system also alerted money managers when they were paying too much for a stock or skirting too close to the law. It flagged them when they were near a breach of their investing mandate by buying too many shares in a particular industry or more than 5% of a particular company's stock.

Who cared? "Nobody on Wall Street," Merrin, 43, recalls. "Who cared about saving a few dollars when they were making gazillions." After some slow going, the idea caught on, and by 1996 Merrin sold Merrin Financial for a figure in the "low eight figures," to Automatic Data Processing, a transaction processing giant based in Roseland, N.J. These days, automated order-management systems are a $600 million-a-year industry.

The Internet era gave him another idea for the Street. He was commuting to Silicon Valley as CEO of a health-care startup that helped professionals exchange research over the Internet when he got the brainstorm for Liquidnet.

SPLIT MARKET. The NYSE, of course, will hold most of the cards for some years to come. It has the largest pool of shares to trade, so that's where traders go most of the time. And it's protected by rules handed down in Washington years ago that discourage traders from routing orders to alternative markets.

But Merrin has a modest proposal to make. The NYSE, he says, should cater exclusively to retail investors, while institutional trades should be funneled to businesses like his. Don't scoff. Some day that just might happen. By Mara Der Hovanesian in New York


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