Updated from Sept. 8

Following the bigger-is-better strategy sweeping Wall Street firms, investment banking giant

Goldman Sachs

(GS) - Get Report

is in talks to acquire trading giant

Spear Leeds Kellogg

, according to two people at competing firms.

The deal would combine Goldman's strengths in underwriting new issues and trading for institutional clients with Spear Leeds' industry-leading franchise in executing orders both in

Nasdaq

stocks and stocks listed on the

New York Stock Exchange

and options exchange floors.

Goldman and Spear Leeds didn't return calls for comment.

Privately held Spear Leeds is one of Wall Street's most storied -- and secretive -- franchises and has been able to build market share on three of the nation's four options exchanges and on the

Big Board

. Spear Leeds has a specialist and market-making business -- essentially acting as a wholesaler or middleman on stock trades -- and a significant business clearing and executing trades for smaller broker-dealers and independent traders.

A deal also could potentially give Goldman a small piece of the

RediBook

electronic communications network (ECN) trading system developed by Spear Leeds. Goldman already owns pieces of the

Archipelago

and

BRUT

ECNs. Electronic trading platforms typically provide low-cost order matching for stock trades and could provide a cost-effective outlet for more of Goldman's customer orders.

"It's more consolidation in search of economies of scale," says one veteran trader at a competing market-making firm. "This is a deal so big it could shake the foundation of the trading business and scare firms like

Timber Hill

and

TheStreet Recommends

Susquehanna

."

Larger institutional brokerage firms are looking to enhance their market-making capabilities, says

Lehman Brothers

(LEH)

analyst Mark Constant, who declined to talk about the possible Goldman deal. (Lehman participated in Goldman's 1999 initial public offering.)

Major Wall Street firms hope to increase the number of trades they execute and also complete as many as possible within their own operation to avoid paying a middleman. For Goldman, bringing Spear Leeds into the fold would be one step in that direction. It also would allow the firm to generate revenue from individual investor orders that are channeled through firms such as Spear Leeds by other brokerage firms.

In June, Merrill Lynch agreed to buy market-making firm

Herzog Heine Geduld

for $914 million. Now, the

Salomon Smith Barney

unit of

Citigroup

(C) - Get Report

and

Morgan Stanley Dean Witter

(MWD)

could be seen as potential buyers of other large market-making firms.

For instance, shares of NYSE specialist

LaBranche

(LAB)

, before getting hit with downgrades this week, were showing some strength based partly on takeover speculation. The firm has said it isn't interested in pairing up.

Goldman showed an early interest in the market-making business when it acquired

Hull Trading

, a tech-savvy derivatives trading firm based in Chicago, in 1999.

Any prospective acquisition would be made easier for Goldman because it can use a strengthened stock price as a currency. Its shares have risen more than 65% since June 1.