Egos on parade as Wall Street ponders future

But whether a 19th century trading system, not to mention a few healthy egos, can make the leap into the electronic age remains to be seen. The first public discussion of the effort took place last week in New York and drew some of the biggest names on Wall Street, who pleaded their cases before the Senate Banking Committee over two days of hearings. A day later, a news report said that the National Association of Securities Dealers and the NYSE were once again discussing a possible merger or alliance. At the hearing, all of the media attention focused on the most far-reaching proposal, the creation of a centralized market for all stock quotes. But that was only one of six ideas offered by the Securities and Exchange Commission to revamp the way stocks are bought and sold. While centralizing the market is expected to be the most controversial suggestion, several brokerage firms are gearing up to challenge a far less-publicized measure suggested by the Big Board. It would prohibit brokerages from filling customer orders from their own inventory unless they give customers better prices than those offered on other exchanges. "That would change the economics of internalization," says Leopold Korins, president and chief executive officer of the Security Traders Association in New York. "From a reward standpoint, it would make it less profitable and less attractive to do it. It would hurt any firm that internalizes order flow anywhere."

Sit and wait

Also among the proposals, regulators are considering whether to require market makers to execute best price offerings, even if they are from buyers and sellers who are not their customers. They would have to do so before making trades at the best price for their own account. Market makers already have to execute best-price offerings of their customers ahead of their own trades. Under that proposal, the market maker "can't sit and wait and see where the price goes and just match it," says Annette Nazareth, director of the SEC's Division of Market Regulation. "It mitigates the problem of having isolated orders that don't get executed. These are methods to encourage quote competition," she says. SEC chairman Arthur Levitt initiated the latest debate over fears that competition among exchanges is leading to damaging fragmentation. Because investors are increasingly placing orders over different exchanges and electronic trading systems, regulators are concerned that buy-and-sell orders are being distorted, or worse, manipulated. The SEC laid out its plan for restructuring the market in six steps, ranging from simply requiring greater disclosure by market centers and brokers of trade executions and order-routing, to the market centralization plan. Based on a past SEC proposal, the disclosure provision would simply require market orders to be exposed to price competition in other markets to ensure that customers get the best price available. Another proposal would prohibit markets from trading ahead of previously displayed investor limit orders from another market center. Currently, market makers can't trade ahead of limit orders from their own customers. The proposal is intended to get greater quote competition. "This rewards people who are ahead of the market maker in time," Ms. Nazareth says. "So many issues are trading at teenies now with no spread, and we're about to go to decimals where the spreads are going to get even smaller," Mr. Korins explains. "I'm not sure that we want to build a second infrastructure as to how we expose an individual order. I'm not sure what is to be gained." He says customers have lodged very few complaints that orders were being bypassed in other markets. Prohibiting market makers from trading ahead of previously displayed limit orders "only works if you have a unitary system. If you want people to supply liquidity, you've got to give them an opportunity to refresh their positions," he says. On market centralization, San Francisco-based discount broker Charles Schwab Corp. emerged as the leading opponent -- on grounds that the plan is anticompetitive. The idea "is not going to be good for customers because it's going to be a disincentive to creating new and efficient kinds of markets," such as the type of electronic networks that Schwab operates, says Schwab general counsel Hardy Callcott. "The problem with fragmentation has decreased since customer limit orders have been displayed in the Nasdaq markets, and ECNs [electronic networks] have been incorporated into the quotes," Mr. Callcott adds.

Limit on competition

The best thing about the web is that when one point of failure occurs, another point picks up. "A unified market doesn't work that way," said Schwab chairman and co-CEO Charles Schwab. Banking Committee Chairman Phil Gramm, R-Texas, questioned whether a unified market might eliminate smaller firms or upstarts from competing. "Not everyone can get on the market," he said. "How do you decide who gets on the market?" As he's argued in the past, Mr. Schwab wants the SEC to take steps to ensure that real-time stock price quotes are made public. "Technologically its easy to do real-time streaming quotes, but it's not economically feasible," Mr. Callcott says. Douglas Atkin, chief executive of Instinet Corp., which is owned by Reuters PLC, believes requiring orders to be executed on a first-come, first-served basis, depending on the best price, would make U.S. markets more competitive. Instinet, the world's largest agency broker trading over 300 million shares daily, has been offered only to institutional investors, but will open to retail ones next month. "Putting firm price-time priority, both within exchanges and between exchanges, will have substantially more impact than anything else that can be done," Mr. Atkin says. "It is only by doing that, that you're going to allow fundamental competition to enter this industry."