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With Grasso Gone, Who Stands to Gain?

The Big Board's competitors are likely to benefit and major brokerages might consolidate power.
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It's axiomatic there are two sides to every trade. So with the ink barely dry on Richard Grasso's resignation as chairman of the

New York Stock Exchange

, some are already contemplating the potential beneficiaries.

Some will argue that "justice" has been served by Grasso's resignation, which, as widely reported, followed revelations of his outsize pay package. If as California Treasurer Phil Angelides said Tuesday, Grasso's departure was necessary for the Big Board to "restore its moral authority" and re-establish "the credibility of our financial markets," then all investors have won.

Indeed, some individuals may take solace that positive change is occurring, and that regulators such as the

Securities and Exchange Commission's

William Donaldson are working to reverse the egregious excesses of the bubble era (and its aftermath). A generous soul might partially attribute Thursday's strong advance to such heightened investor confidence.

But Wall Street is not a touchy-feely place, and the most likely beneficiaries of Grasso's demise are the NYSE's competitors, namely the


and electronic communications networks (ECNs).

In a statement, the Nasdaq Stock Market said: "We hope this difficult decision will allow the NYSE to focus on and successfully address the complex governance, ownership and operational issues it faces. It is important to the integrity of the capital markets that it do so."

Broadly, the Nasdaq and the Big Board differ operationally in that the former is a decentralized, computerized trading platform while the latter is still dominated by human beings, known as specialists.

"Dick was a fierce, intelligent, compassionate competitor. It's like Michael Jordan retiring," said Jerry Putnam, chief executive of Archipelago, one of the four original ECNs approved by the SEC in 1997. This year, the firm migrated trading of over-the-counter securities from the ECN to its "ArchaEx" exchange platform, which handles more than 30% of daily volume in big-cap names such as


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Grasso's departure may be a boon to Archipelago and ultimately allow it to handle similar volume in Big Board names such as


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, Putnam continued. "But the biggest hurdle we face is the monopoly power the NYSE has and the regulatory power it has."

Separating the exchange's regulatory power from the marketplace, as the National Association of Securities Dealers has done with the Nasdaq, is reportedly under consideration. Theoretically, such a change could allow competitors such as Archipelago and Instinet's Island ECN to make the same inroads in Big Board names as they have with Nasdaq stocks. (NYSE members were meeting Thursday afternoon, and its board it slated to meet Friday to discuss these and other issues.)

While less than 20% of the volume of over-the-counter stocks is traded by the Nasdaq, about 80% of the volume of Big Board names is still traded via the specialist system. Grasso's supporters say that figure is a testament to his success, and why his departure may weaken the exchange.

"Grasso was a master of reconciling the interests of the floor members with the need to be technologically up-to-date and compete with ECNs," said Wayne Wagner, chairman of Los Angeles-based Plexus Group, which advises institutions on trading execution. "He walked that fine line very well. Anything that changes that could make for a momentous shift," and to the advantage of ECNs.

Follow the Money

To detractors, Grasso's package and the specialists' continued dominance evince how the Big Board's cliquish culture has thwarted competition and hurt investors.

"The thing that galls our clients is that a not-for-profit entity can pay these obscene amounts," said Steve Merrin, CEO of Liquidnet, an electronic exchange designed exclusively for institutions. Grasso's compensation is "another data point in a whole problematic issue that is the NYSE."

The average institutional order exceeds 50,000 shares, while the average size of NYSE trades has fallen to 500 shares vs. 2,000 a few years ago, according to Plexus Group's Wanger. As the trading gets chopped up and strung out over time, "you can have a situation where people paying close attention can see a steady buyer or seller and trying to exploit that," he said, ultimately hurting the individual shareholders often represented by institutions.

The only immediate competitive advantage Merrin could envision from Grasso's resignation is the "continued scrutiny of all NYSE practices," with his compensation being a catalyst for more examination. "On the heels of the scandal, there's going to be some changes made."

Of course, it's difficult to say what, if any, changes will emerge, and "you'd rather deal with devil you know than devil you don't," he said.

The Devil Upstairs

Some observers believe the ultimate winner of Grasso's ouster will be the so-called upstairs market, i.e., trades not listed on the exchange but negotiated "off market" between brokerages.

As pressure mounted against Grasso this week, he lost the support of Wall Street's largest firms, including

Goldman Sachs

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J.P. Morgan Chase

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Morgan Stanley



Credit Suisse First Boston


"It's interesting this happens to Grasso after all the major floor powers were absorbed by upstairs firms," observed one former specialist now working in academia. Indeed, there has been a slew of deals in recent years: Goldman acquired Spear, Leeds & Kellogg,

FleetBoston Financial


acquired M.J. Meehan,

Merrill Lynch


acquired Herzog Heine Geduld,

Bear Stearns


bought Wagner Stott Mercator, and Deutsche Bank acquired Sherwood Securities from the parent of National Discount Brokerage before it was acquired by


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The merger activity undermined conventional wisdom that the specialists business was unprofitable and left



as the lone major independent specialist firm.

"The only reason the NYSE became what it was, was you couldn't internalize order flow and step in front of the customer," said the source, who requested anonymity. (Internalization is when dealers match buyers and sellers in their own order books -- without giving specialists a chance to fulfill the order.) "If you internalize order flow and don't expose it to the competitive market, you make much more money, more easily."

Noting that Grasso was an "ardent advocate of the virtues of the exchange," he accused the upstairs firms of a "conspiracy of silence." Ultimately, they may have supported Grasso's ouster because they saw a better opportunity under another chairman to pursue their ultimate goal of internalizing orders, he suggested.

"Everyone wants to internalize orders instead of taking it to the floor," Wagner said. "The desire is obvious. Whether there's a cabal to do that is another thing."

Others agreed there's little evidence Grasso was victimized by nefarious forces, and Archipelago's Putnam argued that specialists "already internalize flow for

their own benefit."

Maybe so. But it's not unthinkable that Grasso's departure will ultimately create more power for the major brokerages rather than increase competition among exchanges and platforms. If that happens, the ultimate winners of this drama will be Wall Street's fattest cats and the losers the investing public. History has shown that's usually the case.

Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.