With Grasso Gone, Who Stands to Gain?

The average institutional order exceeds 50,000 shares, while the average size of NYSE trades has fallen to 500 shares vs. 2,000 a few years ago, according to Plexus Group's Wanger. As the trading gets chopped up and strung out over time, "you can have a situation where people paying close attention can see a steady buyer or seller and trying to exploit that," he said, ultimately hurting the individual shareholders often represented by institutions.

The only immediate competitive advantage Merrin could envision from Grasso's resignation is the "continued scrutiny of all NYSE practices," with his compensation being a catalyst for more examination. "On the heels of the scandal, there's going to be some changes made."

Of course, it's difficult to say what, if any, changes will emerge, and "you'd rather deal with devil you know than devil you don't," he said.

The Devil Upstairs

Some observers believe the ultimate winner of Grasso's ouster will be the so-called upstairs market, i.e., trades not listed on the exchange but negotiated "off market" between brokerages.

As pressure mounted against Grasso this week, he lost the support of Wall Street's largest firms, including Goldman Sachs (GS), J.P. Morgan Chase (JPM), Morgan Stanley (MWD) and Credit Suisse First Boston.

"It's interesting this happens to Grasso after all the major floor powers were absorbed by upstairs firms," observed one former specialist now working in academia. Indeed, there has been a slew of deals in recent years: Goldman acquired Spear, Leeds & Kellogg, FleetBoston Financial (FBF) acquired M.J. Meehan, Merrill Lynch (MER) acquired Herzog Heine Geduld, Bear Stearns (BSC) bought Wagner Stott Mercator, and Deutsche Bank acquired Sherwood Securities from the parent of National Discount Brokerage before it was acquired by Ameritrade (AMTD).

The merger activity undermined conventional wisdom that the specialists business was unprofitable and left LaBranche (LAB) as the lone major independent specialist firm.

"The only reason the NYSE became what it was, was you couldn't internalize order flow and step in front of the customer," said the source, who requested anonymity. (Internalization is when dealers match buyers and sellers in their own order books -- without giving specialists a chance to fulfill the order.) "If you internalize order flow and don't expose it to the competitive market, you make much more money, more easily."

Noting that Grasso was an "ardent advocate of the virtues of the exchange," he accused the upstairs firms of a "conspiracy of silence." Ultimately, they may have supported Grasso's ouster because they saw a better opportunity under another chairman to pursue their ultimate goal of internalizing orders, he suggested.

"Everyone wants to internalize orders instead of taking it to the floor," Wagner said. "The desire is obvious. Whether there's a cabal to do that is another thing."

Others agreed there's little evidence Grasso was victimized by nefarious forces, and Archipelago's Putnam argued that specialists "already internalize flow for [their] own benefit."

Maybe so. But it's not unthinkable that Grasso's departure will ultimately create more power for the major brokerages rather than increase competition among exchanges and platforms. If that happens, the ultimate winners of this drama will be Wall Street's fattest cats and the losers the investing public. History has shown that's usually the case.

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