Archipelago Forces Trading Industry to Take Stock
By Caroline Humer
Staff Reporter
7/27/99 9:03 PM ET
It's a bit clearer now why Dick Grasso is in such a hurry to turn the New York Stock Exchange into a sleek, publicly traded outfit.
In a drastic move Tuesday, upstart electronic communications network Archipelago said it would file for exchange status and that it had received a major investment from Instinet, a unit of Reuters (RTRSY:Nasdaq ADR), which has electronically traded NYSE-listed stocks after hours for more than two decades. Instinet's 16% stake in Archipelago cements an alliance of two significant rival electronic trading platforms that will put even more pressure on the Big Board and Nasdaq.
In an environment that's quickly turning upside down, Instinet's move is a hedge that many firms concerned about the impact of new electronic trading venues are making these days. Just last week, Charles Schwab (SCH:NYSE), Fidelity and Donaldson Lufkin & Jenrette (DLJ:NYSE) lined up for 25% stakes each in Spear Leeds & Kellogg's ECN REDIBook.
Instinet had reportedly been in discussions with NYSE and Nasdaq, but chose Archipelago -- a move that highlights the need for change at the two established exchanges.
The deal also puts the two older exchanges in competition with their own members. The potential new exchange has some of the NYSE's and Nasdaq's biggest names as its investors, including J.P. Morgan (JPM:NYSE), Goldman Sachs (GS:NYSE) and E*Trade (EGRP:Nasdaq).
Douglas Atkin, Instinet's president and chief executive, says that as the U.S. market moves toward for-profit exchanges, Archipelago is one of a few bets Instinet is willing to make.
"We think Archipelago, with its strong backbone, distribution and business model, is a sure bet to be one of the winners of getting to a for-profit exchange the quickest," he says.
If the NYSE and the Nasdaq make changes, Instinet will then be supportive, maybe even investing in a potential NYSE IPO, Atkins says. Instinet itself, he says, won't put together its own exchange application but instead will concentrate on this strategy of becoming a global brokerage. Earlier this year, the Securities and Exchange Commission began allowing alternative trading systems to apply for exchange status.
At least one other Archipelago ECN competitor, Datek Online Holdings' Island, is working on its application.
Gerald Putnam, Archipelago's chief executive, estimates the exchange application process with the SEC will take nine to 18 months and adds that the company is also planning for its own stock market listing sometime next year.
According to the June Nasdaq numbers, Archipelago is the fourth largest of the nine ECNs. Like other ECNs, it matches buy and sell orders electronically, charging a per-share commission to its clients -- which Putnam says are a mix of retail, institutions, brokers and market-makers. Currently, ECNs operate within the Nasdaq market structure, exploiting the links that the electronic screen-based exchange offers.
But they have no links into the NYSE and that's actually one of the main reasons that both Archipelago and Island want to become exchanges. "We can't publish a quote from our book and have it in the national quote system. The only way we are going to be able to break through those barriers is to become a stock exchange," Putnam says.
Ian Domowitz, a finance professor at Penn State who has been writing about stock markets and electronic trading for 10 years, says somebody has finally moved into the era of change he's been expecting.
"They've been treating the trading service industry as though it was something special, some clubby thing to which normal business principals didn't apply. They had the idea the people would go to certain places because of the idea of power. But the trading services industry is actually an industry," Domowitz explains.
And like in other industries, the usual rules apply, says Kenneth Pasternak, Knight/Trimark Group's (NITE:Nasdaq) president and chief executive. Knight owns a minority stake in a competing ECN, BRUT, but is primarily a Nasdaq market-maker that has gained a dominant market position in the past year due largely to the growth of online trading. Knight is working with the exchanges and hasn't invested in any other exchanges, Pasternak says. But that doesn't mean the market-maker won't do so if such an investment would improve execution, he adds.
"Certainly if you look at the history of business, privatized enterprises tend to move a lot faster than quasi-government agencies," he says. "Where barriers to entry are speed and access to capital, a private company can get there better, faster, quicker than a mutualized company."
And that's just what Atkin is betting Archipelago will do.
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