Levitt's Plan for Combined Exchange Regulation Brings a Quick Round of Questions

Will the SEC chief's idea for one regulator over all stock exchanges pass muster? Wall Street wants details first.
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It may be Wall Street's strongest reaction ever to a speech not yet given.

And before

Securities and Exchange Commission

Chairman Arthur Levitt tries to consolidate the regulatory duties of the stock exchanges under one unit, a plan he's expected to discuss Thursday in a speech at

Columbia University

, he's going to hear from every corner of the market.

Levitt's likely to get an earful about his plan -- reported in

The Wall Street Journal

Tuesday -- from critics who think overall regulation would suffer if one body tries to police a fragmented market, while others see it as the only recourse in a world of publicly traded stock exchanges.

"At the end of the day, you have to ask whether bringing the regulation of the financial community under one regulatory body is an attractive goal," says Robert Smith, managing director of financial institution research at

Salomon Smith Barney

. Smith says it has not been demonstrated to the market that it is "critically important for everything to be under one roof."

"It will be interesting to see if this concept has any legs," Smith adds.

Many Wall Street players are watching the situation with interest but withholding their comments until they get more information. A spokesman for the

New York Stock Exchange

says the exchange has no comment yet, but points out that NYSE Chairman Richard Grasso will be addressing the issue before Congress at the end of this month.

Likewise, a spokeswoman for the

National Association of Securities Dealers

, which oversees the

Nasdaq

exchange, says it would be premature to comment on a speech not yet delivered. An SEC spokesman also had no comment.

With both the Nasdaq and NYSE exploring initial public offerings, there's concern that allowing them to regulate themselves would present conflicts of interest. Throw into that mix the emergence of electronic trading platforms such as

Datek's Island

, which don't have enforcement or regulatory arms, and the landscape is rockier than just two years ago.

"I think what Levitt is trying to do is put all the exchanges on a level playing field," says Scott Fullman, chief options strategist for

Swiss American Securities

.

A single regulatory body may also make the job of the broker/dealers easier, Fullman adds. Currently, a broker/dealer must face audits from the NYSE, the Nasdaq and the SEC, and perhaps even regional exchanges, in order to trade stocks on those exchanges. "The time, cost and effort involved is terrible," says Fullman.

Underlying this push for action, according to several market watchers, is the SEC's (and

Justice Department's

) belief that further electronic competition for order flow among exchanges and ECNs will lead to more efficient markets. That belief throws a wrench into the machinery of the NYSE and Nasdaq.

And while many agree that some sort of consolidation is necessary, others voice concern that a lower quality of overall regulation could be the result. "The concept of a singular regulatory control may be a seductive one," says one NYSE member who requested anonymity. "But if the lessening of regulations to a level below which the NYSE operates is the outcome, then who would be in favor of that?"

The NYSE member pointed to the fact that Levitt has sought help from Wall Street investment banks

Goldman Sachs

(GS) - Get Report

,

Merrill Lynch

(MER)

and

Morgan Stanley Dean Witter

(MWD)

, each of which have a stake in the further competition away from the NYSE. Each has made significant investments in ECNs and alternative trading systems that obviously benefit from lower trading costs. Morgan Stanley and Goldman Sachs did not return calls. A Merrill Lynch spokesman had no comment.

"Those

investment banking firms lost millions when the SEC imposed order-handling rules," the NYSE member says. "Now, I think they see a chance to take the first step to dismantle the U.S. securities market in the name of further competition." Under order-handling rules established in 1997, the SEC forced broker/dealers to post customer orders to ensure better competition for best price. The practice narrowed the spreads on which broker/dealers make their money, and cut into the profits of the firms.

Yet there's no doubt that concerns are also based in emerging turf wars between traditional exchanges and upstarts. "If the NYSE is worried about this proposal, then it should also be worried about where it is heading amid an increasing e-market," says Robert Schwartz, a professor at the

Zicklin School of Business of Baruch College

in New York.

Indeed, the worst-case scenario for the NYSE would be if the markets become more electronic-based and interconnected and the SEC goes ahead with its plan to allow NYSE-listed stocks to be traded elsewhere, says Schwartz. "What's going to be left of the NYSE as we know it if that happens?"

Since the competition genie can't be put back in its bottle, the NYSE, its floor brokers and old-line Nasdaq market makers are facing a new world. "Now it's up to the SEC to get the regulatory side up to par with the changes of the market," says Fullman.