Oversight Hearings: The Exchanges Fight Over the Future

The NYSE pitches its view of the market's structural future, but others see things differently.
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WASHINGTON -- The Old Economy sparred with the New Economy again Wednesday. Only this time, the issue wasn't the latest price gyrations on Wall Street -- it was the future structure of the stock market itself.

In the latest in a series of oversight hearings, the securities subcommittee of the

Senate Banking Committee

heard a group of financial market executives wrangle over competition and market "transparency" -- the idea that the more market trading and price information is available, the better.

For the broad swath of Americans invested in stocks, the bottom line of Wednesday's hearing will likely be whether, in the markets of the future, investors can trade at better prices or with lower transaction costs -- even if the differences represent only pennies on the dollar.

That kind of difference may not sound like much, but even small amounts can translate into hundreds of millions of dollars annually in higher investor costs, once multiplied across the hundreds of billions of shares that change hands each year.

"To state that our securities markets are in a major transition would be to understate the obvious," said Sen. Rod Grams, R-Minn., subcommittee chairman.

Getting Interconnected

The standard bearer for the Old Economy at the hearing was

Richard Grasso

, chairman and chief executive of the

New York Stock Exchange

, who used the occasion to tout the NYSE's vision of a stock market without walls: One, Grasso said, in which all trading venues are highly interconnected, so that investors can always be assured of getting the best prices on their trades.

Emblematic of the New Economy was Kenneth Pasternak, president and chief executive of the upstart

Knight/Trimark Group


, which in less than five years has become


biggest trading firm, now handling almost 20% of its volume. He and others, while expressing support for competition and transparency, were nevertheless skeptical about the old-institution NYSE and its proposed future role.

Appearing separately from the other executives, Grasso pushed the NYSE's new "Market Structure Report," which contains a number of initiatives designed to improve pricing, cost, speed and reliability of trades.

A 25-year-old price link among markets, known as the Intermarket Trading System, is creaky with age and should be scrapped, he said. In its place, a centralized system of "total transparency of all competing arenas" should be created, to interconnect pricing from all venues, whether traditional exchanges or newer computer-based systems known as ECNs and ATSs -- electronic communication networks and alternative trading systems.

Then, he said, although prices would be tightly linked, the exchanges and other players would otherwise compete aggressively for orders. However, any entity executing an order would always be obliged to do so at the best prevailing price, even if that price was found in another venue.

"We need to structure the market from the standpoint of investors, not intermediaries," Grasso said. The plan won't be possible without the support of


and the

Securities and Exchange Commission

, he said.

Broker-Dealers and Another Proposal

While the NYSE has pushed its plan to legislators and the SEC, which ultimately will decide on changes, Wall Street's largest broker-dealers are lobbying Washington to get behind a competing proposal. It would keep the Intermarket Trading System but upgrade it in an effort to assure fair price execution.

But the big brokers' notions evoke concern about "fragmentation" -- what happens when orders flow not to one central location, such as the NYSE, but instead are divvied up among several venues.

Fragmentation can hurt investors' ability to get the best price, some warn, because it prevents buyers' and sellers' collective sentiments from being gathered all in one place. If, for example, all vegetable prices are represented in one supermarket, buyers can be assured they're getting the best price. But if the best produce deals are tucked away in other stores, that may not be true.

"Orders to buy and sell may be isolated, preventing them from meeting," said John Bachmann, managing director of

Edward Jones Investments


Specifically Doubtful

Others appearing before the subcommittee endorsed some of the same broad themes as Grasso, but remained doubtful on specifics.

Pasternak warned of any "monolithic, single market imposed by government decree," especially one not independent from any market player. He rejected fragmentation as a major concern, saying technology has done wonders for market efficiency, and consolidation among securities firms has likewise reduced opportunities for significant pockets of unconnected trading.

"Those raising the most concerns about fragmentation are really afraid of competition," he said. "The call for market reform is really a call for rolling back the clock."

Harold Bradley, senior vice president of

American Century Cos.

, the mutual fund holding concern, likewise voiced concerns about NYSE's role and power in any new system. While NYSE volume has exploded in the past decade, commissions haven't responded by going down, as would be expected, he said, but instead have remained flat.

Meanwhile, he noted, a NYSE plan to provide access to its floor specialists' order books -- which can provide critical information for understanding where the price of a particular stock may be headed -- is slated to be done through intermediaries, who must be paid for providing the service. With today's computer capabilities, he said, "that's ridiculous."

David Colker, president and chief operating officer of the

Cincinnati Stock Exchange

, also warned against Grasso's vision. "Those people would have you believe you only get the best price by having all orders interact in New York or some neutral location," he said. "But worries about fragmentation should be seen for what they are: an attempt by the primary market to retain advantage by regulatory fiat."

In the end, chairman Grams wasn't ready to pronounce a consensus on any need for regulators to step in. "Everyone agrees there needs to be more openness," he said in an interview. "Maybe some of the concern is who develops, maintains and controls those systems."