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These days, the floor of the New York Stock Exchange is like a technology trade show. Floor brokers and clerks bristle with handheld electronic gear, and top-of-the-line flat screens are visible everywhere. The exchange likes to boast that, over the past decade, it has spent $2 billion on technology to speed investor orders to its floor and hasten the posting of completed trades to the public.
But the exchange has long held sacrosanct what happens in between: the matching of buyers and sellers by human specialists and the participation of floor brokers in an "open-outcry" auction. Over 211 years, the NYSE has built near-impenetrable walls around the humans who, it insists, are essential to setting the best prices for shares.
Those barriers are crumbling. The Big Board is about to allow widespread automatic matching of anonymous buyers and sellers -- much like its archrival NASDAQ -- often bypassing specialists and stopping opportunistic floor brokers from jumping in to snatch parts of large orders. As a result, trading costs should fall, and investor returns should get a boost.
Powerful forces are propelling tectonic shifts at the exchange. The biggest push comes from its regulator, the Securities & Exchange Commission. Insiders say the SEC is about to change its rules to allow electronic rivals to bypass the NYSE -- even if slightly better prices are available there -- unless the Big Board allows more automatic execution of trades. There is pressure, too, from big mutual funds that are under the gun to cut trading costs. And the NYSE's new management, led by former Goldman Sachs Group Inc. (GS
) President John A. Thain, hopes quickly to restore the exchange's reputation, tarnished by the forced departure of former Chief Executive Richard A. Grasso and a damaging probe into floor-trading abuses. Says John J. Wheeler, head of equity trading at mutual-fund group American Century Investment Management Inc.: "All these pressures have combined to break the auction market, which has outlived its usefulness by 100 years."
For specialists, those pressures had become unbearable. On Jan. 20, they invited the head traders of five fund companies to meet at the offices of Fleet Specialist Inc. (FBF
), across the street from the marble-colonnaded NYSE. Fleet and four other firms that execute most of the NYSE's trading were willing to support electronic matching of orders whose buy and sell prices exceed or match the best quotes available. There would be no limit on the number of shares that could be matched. The fund reps, according to one who was present, couldn't believe their ears. He says up to 70% of all NYSE orders could be affected -- a revolutionary development for a stock market that relies on humans to execute 94% of its trades.
Since then, NYSE members, floor brokers, and employees have been ushered into meetings to hear about the ambitious plans, and SEC officials have been briefed. On Feb. 5, the NYSE board was set to vote on the proposals. While change was in the air late last year, the overhaul sped up dramatically with the Jan. 15 arrival of CEO Thain, a techno whiz who helped persuade Goldman to invest in Archipelago, one of the NYSE's electronic rivals. Indeed, just before the Jan. 20 meeting, Thain O.K.'d the specialists' initiative, even offering ways to improve it.BIGGER ORDERS. No one knows how much NYSE trading will be done automatically. But few dispute that the impact will be huge. If Thain wins board approval and the SEC goes along, many of the large block trades negotiated by Wall Street firms' trading desks could sidestep the floor altogether. Similarly, orders that arrive at the specialists' post via the NYSE's electronic order system could also be handled electronically. The ability of large customers, such as mutual and pension funds, to bypass the floor is likely to slow the loss of market share to e-rivals. Also, it would likely boost the average size of orders, now just 500 shares.
Under the plan, the NYSE's existing matching system, called Direct Plus, would handle automatic trades. Since its 2002 debut, Direct Plus has been a disappointment. Currently, trades are limited to 1,099 shares, and customers must wait 30 seconds between executions. Both constraints will now be lifted. American Century's Wheeler estimates that he could save $300 million to $400 million on the cost of trading $100 billion worth of stocks annually.
On the other hand, the NYSE could lose business if customers send their NYSE orders to rivals such as NASDAQ or INET -- the new name of the merged Island and Instinet electronic networks. Some offer advanced features, such as letting customers tease out others' trading interest without giving away too much of their own strategy. At least, that's what the electronic markets hope. Says Gerald D. Putnam, chairman and CEO of Archipelago Holdings LLC: "They're going to have to become a lot more competitive to stay ahead of us."
Mutual funds and other big investors have long complained that the auction market drives up costs and slows down trading. It takes an average of 16 seconds to complete NYSE trades. Archipelago, by contrast, takes one second.
To appease those willing to give up a few pennies a share for faster trades, the SEC, according to insiders, soon will propose a change in its stock-handling rules. Currently, the agency bans one market from "trading through" a better price at another market. In other words, orders must go to the exchange that offers the best price -- often the NYSE.
SEC insiders say Chairman William H. Donaldson is prepared to modify the rule so a market can complete a trade at a price that's 2 cents or 3 cents a share worse than what's on offer elsewhere -- provided the other market can't execute trades automatically. The bottom line: The change would allow electronic rivals to bypass the NYSE floor as it now works.MUTUAL-FUND RELIEF. But thain isn't about to let the SEC deem the exchange the "slow market" that anyone can ignore. That threat explains the NYSE's leap into the electronic world, says Robert H. McCooey Jr., CEO of Griswold Co., which employs 24 floor brokers. Recently, Thain asked SEC officials to mandate that all markets implement auto execution so he can present it as a fait accompli to Big Board members and avoid a fight. Not wishing to micromanage the markets it oversees, the SEC isn't likely to do that. But it's also not likely to ditch the trade-through rule entirely, as NYSE rivals want.
Even so, an amended rule will change the familiar scene on the NYSE floor. Jobs almost certainly will be lost, especially among the 400 or so floor brokers. Some mutual funds will still rely on them to get better prices but others aren't likely to shed tears if they disappear. Why? When Merrill Lynch & Co.'s (MER
) trading desk matches a buyer and seller on a large block of stock, it must send the trade to the specialist for execution. At that point, NYSE rules allow floor brokers to "interact" with the order. If the trade is for 10,000 shares, a broker in the crowd can take, say, 2,000 shares, forcing Merrill's buy-side customer to find another seller, most likely at a higher price.
For Thain, the risk is that, once he opens the door to electronic trading, he may not be able to control it. Already, mutual funds are pushing to expand auto execution to all orders specifying a size and price, not just those at the best buy-and-sell quotes. And floor brokers soon will be able to use handheld devices to execute customer orders with a specialist from anywhere on the floor. That's another nick in the auction model. A nick here and a nick there, and soon, the NYSE and the NASDAQ could become indistinguishable. By Paula Dwyer, with Amy Borrus, in Washington, and Gary Weiss in New York