WASHINGTON -- Imagine yourself a devotee of tomatoes. You head off to the local market in search of some "big boys" or maybe some early season "first ladies."
When you arrive, there are plenty of tomatoes to be had, with a sign prominently displaying what your grocer wants before he'll part with them.
But what if you knew that a new shipment was due soon? And yet another one tomorrow? Or that charging down the aisle right behind you was an army of motivated tomato shoppers?
Could any of that information affect your decision whether to grab a bagful and head for the check-out?
And that experience is akin to what could be Wall Street's next revolutionary change. If the reform comes to pass -- and the
Securities and Exchange Commission
is now warning it wants action -- it could break down one of the biggest barriers separating small investors and the financial industry's most powerful players.
It's called "limit order transparency," and it rests on the same idea that might help tomato buyers: If you provide investors with more information about the overall supply and demand -- in this case, the accumulated buy and sell orders for a particular stock -- they'll be in a position to make better investment choices.
Limit orders, which have become a favorite tool of individual investors, are instructions to buy and sell at specific prices. Today, they've become the dominant form of trading on both the
Nasdaq Composite Index
New York Stock Exchange
At any given moment in trading, there is a market price -- the current going price -- for a stock. Likewise, a certain amount of shares trade hands at that price. But lurking behind that market activity is a stack of limit orders, representing shares investors will buy or sell at prices different than the current market price.
While knowing the market price is helpful, knowing the full queue of buy and sell orders can be vastly more informative. Are there lots of buyers lined up at prices close to the market price? That could mean the price will soon pop. Lots of sellers? The opposite, of course. Some balance between the two? Maybe the price will sit tight for a while.
Simply "knowing that a thousand shares are available at a certain price doesn't tell us much about where the (overall) market is," said Robert Pozen, president of
Fidelity Management and Research
So while market prices expose the top slice of the market, limit order transparency would make the full panoply available far and wide.
"It's one more step toward leveling the playing field," said Stephen C. Richards, senior vice president of the
, an online trading firm popular with individual investors.
As repositories for customer orders, Wall Street's big players have long had access to that information. But today, they pretty much keep it to themselves. The biggest plus in giving it up would be the information advantage it conveys to smaller investors. But it also would tend to curb any trading abuses by firms. Rules are already in place to bar such trading, but enforcement activities show it sometimes takes place.
Last week, the SEC held a roundtable discussion that, for the first time, assembled a broad swath of the industry to consider limit order transparency. SEC Chairman Arthur Levitt used the occasion to telegraph that he expects a voluntary solution from the industry, and will lose patience if that doesn't happen.
"I am hopeful the industry will quickly do the right thing," he said. "I think everyone knows we expect it to be moved quickly."
Roundtable participants, while generally supporting limit order transparency, indicated that some nagging questions need to be resolved. Among them:
- How much information should be provided? Should, for example, a stock's "order book" show each pending order to buy or sell, or should the amount of shares offered at a particular price be lumped together and reported as a group? In other words, it's one thing to know that ten 10,000-share orders are pending, but quite another to know a single 100,000 order is lurking. "That is very valuable information to the market," said Bernard L. Madoff, the outspoken chairman of Bernard L. Madoff Investment Securities. "A lot of small orders do not have the information of a large order."
- How should information be shared? Would third-party vendors buy and distribute the information? If so, at what cost? How would discrimination against some would-be purchasers, such as competitors, be barred? "We want fairness laid over this, so everyone can get the information," said Catherine R. Kinney, group executive vice president of the NYSE.
- Seeing great pricing is one thing, but "where do you go to trade with that order?" asked Kevin Foley, manager of electronic trading for Bloomberg LP.
- Must everybody play along? Will participation be mandatory, and if some players can opt out, doesn't that seriously compromise the very intent? To ensure that everyone wants to play along, should there be protection for those who open up their order books? Simply put, should those who post prices be given first dibs on any trading, before anyone else can get better terms? "If I could have it all, I'd like full exposure, as long as our limit orders are protected," said Peter Jenkins, managing director of Scudder Kemper. "Anything you expose to the book should have some kind of priority."
There's also worry that any new system would create new opportunity for mischief. Daytraders might flock to the information like moths to a porch light, some say, and momentum investors could likewise be drawn in. That could complicate liquidity and volatility, they warn.
"It's naive to think you won't have potential abuses of this extra transparency," said Madoff. But "it's not a reason not to do it."
Already, some progress has been made. The NYSE is laying plans to open up its order books by the end of the year.
, a computerized trading system that allows display and matching of buy and sell orders for retail and institutional investors, already makes its order books available on the World Wide Web. Other players also do this, or plan to.
But a solution that reaches across all markets, all the time, remains the Holy Grail.
Why would the industry be willing to give up what has been among its crown jewels?
Basically, there are new realities of the marketplace, said Richard Ketchum, president of the
National Association of Securities Dealers
-- the speed of today's trading, the narrowing of price increments and investors demanding more control over their holdings.
Put another way, at least some of the balance of power has shifted -- not through government fiat but instead through the same "competitive market forces" that Wall Street likes to tout as the beacon of capitalism. Only this time, it's big players like the NYSE and Nasdaq that are under the gun, as trading begins to migrate elsewhere.
"Like it or not, it's time to sit here and talk about transparency," said Michael W. Clark, managing director of
CS First Boston
So after a frenzied decade of change, tomato buyers may yet gain more control over their own affairs.