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Pacific-Archipelago Deal Fills Holes for Both Sides

But the pairing of an ECN and a regional exchange doesn't mean the end is near for the Big Board.

Electronic trading systems moved another inch -- or maybe a foot -- Wednesday toward the center of the rapidly evolving new market structure.

During the last year, major securities firms have embraced these one-time bad boys as the answer to the rapidly changing stock-trading business. And today one of the ECN world's poster children,


, was taken into the embrace of the

Pacific Exchange

in a market marriage that addresses major needs for both operations.

The P-Coast agreed to buy a stake in Chicago-based electronic communications network Archipelago for an undisclosed amount and use its system to trade equities.

As a result, the San Francisco-based Pacific, which trades

New York Stock Exchange


American Stock Exchange

listed stocks and has a separate options floor, gets Archipelago's electronic trading platform. The deal also accelerates the process of phasing out the Pacific's equity-trading floors in San Francisco and Los Angeles.

Archipelago gets access to trade NYSE-listed shares and the regulatory framework of a full-blown exchange.

Whither the Big Board?

This union of new and old doesn't exactly mean the bells are suddenly tolling for the New York Stock Exchange. That exchange has its own plans to start electronically trading smaller orders and so far the NYSE retains its strong hold on trading very large institutional orders.

An NYSE spokesman says the P-Coast-Archipelago partnership doesn't change the Big Board's electronic trading plans and that the exchange is proceeding on course.

Archipelago, despite its star-studded list of investors including

Goldman Sachs

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J.P. Morgan

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, was far from receiving stand-alone stock exchange status. The

Securities and Exchange Commission

has been reviewing its application for the better part of the last year.

Preferential Treatment

The Pacific, meanwhile, faces regulatory changes in the expected repeal of the NYSE's Rule 390, which prohibits NYSE members from trading listed stocks off the floor. That creates a role for regional exchanges that may very well put an end to its current market in the equity-trading business.

"What the Pacific Exchange and also the Cincinnati and Boston

stock exchanges have been surviving on is order preferencing," explains John Coffee, a law professor and financial markets expert at the

Columbia University Law School


Unlike the NYSE, regional exchanges allow a broker-dealer first dibs at trading with his customer as long as the offer is as good as any other existing offer -- thus called order preferencing. "With the approaching elimination of Rule 390, the need to do it on a regional exchange is reduced," Coffee says.

P-Coast Chairman Phil DeFeo says Archipelago will bring new liquidity to the exchange. "Increasingly we want to be more of a destination," DeFeo said. In turn, that liquidity will provide the opportunity for price improvement, an increasingly important point with regulators. At the same time, it will lower costs as the exchange gradually cuts out floor-based equity trading.