Electronic Trading Threatens Big Board, 'Specialists'
Bloomberg
Corso swaps the coat of his blue pin-striped suit for a black trader's jacket and crosses the street from his office to the New York Stock Exchange floor. ''I'd be lying if I told you I didn't have butterflies in my stomach,'' says Corso, a 37-year-old managing director at LaBranche & Co.
For two days his firm has been ''leaning against the wind'' -- buying shares in Merck & Co., Lucent Technologies Inc. and AT&T Corp., among others -- as part of its mandate as an NYSE ''specialist'' to keep stocks trading smoothly even as prices on the Dow Jones Industrial Average tumbled 231 points one day and 185 the next, a 4 percent drop in all.
As a result, LaBranche is holding about $150 million of stock, a big position for a firm with $250 million in capital. About $50 million is tied up in Tyco International Ltd., which slid 6 percent the previous day after a fund manager suggested the electronics company inflated its profits.
Now, on Oct. 14, Corso is facing a Tyco ''breakout,'' an avalanche of sell orders and no apparent buyers. Muscling past brokers on the Big Board's floor to Post 12, the oval kiosk where trading in Tyco takes place, Corso eyes computer screens flashing sell orders -- and faces the prospect of a precipitous plunge in the world's largest maker of electrical connectors.
''Tyco is getting ugly,'' Corso mutters. ''Slow it down, slow it down! Come on, this is a disaster!''
The fate of a single stock seems but one worry these days for the NYSE's 480 specialists, the traders who maintain markets in specific stocks -- and try to make money for themselves in the same stocks.
Fast-growing electronic trading networks have begun to threaten the Big Board and this shrinking core of specialist firms. Half the specialist firms in business a decade ago have been swallowed by rivals. The 27 left are so stretched for money that some people question whether they could weather a market slump. The Big Board plans to extend its hours and to trade stocks priced down to the penny, instead of in fractions, casting even more doubt on the already-uncertain future of the specialists.
'Dinosaurs'
Since July, when NYSE Chairman Richard Grasso disclosed that the exchange was mulling an initial public offering to help fund a move toward more automated trading, debate over the exchange's future has hinged on what role, if any, specialists -- and indeed human brokers -- would play in executing stock trades.
Over the past two years, electronic trading systems have started to offer faster and cheaper ways to match buy and sell orders. Merrill Lynch & Co., Morgan Stanley Dean Witter & Co. and other large, influential exchange members are urging the NYSE to automate --and themselves are investing in competing systems.
Advocates for automated trading systems known as electronic communications networks, or ECNs, see the NYSE as an anachronism, a captive of its venerable history.
''These guys on the floor are dinosaurs,'' says Christopher Concannon, a former Securities & Exchange Commission lawyer who works for Island ECN Inc. ''You simply don't need a human being to do what a computer can do better and faster.''
At a time stock exchanges in London, Frankfurt and Paris have abandoned trading on exchange floors for electronic networks, the 207-year-old NYSE insists that no computer can rival its system of pricing stocks through face-to-face auctions.
Specialists say they are essential in maintaining liquidity -- making sure sellers always find buyers -- for all the Big Board's 3,775 stocks. The role emerged in the 1870s when, exchange lore has it, a member broke his leg and was forced to stay in one place, handling his favorite stock.
Nonstop Trading
Grasso, for one, believes the NYSE must embrace electronic trading, though he hasn't come out yet with a plan that could threaten the exchange's specialist firms. The Big Board, he says, must buy or build its own electronic communications network, though specialists will still have a role to play.
ECNs -- systems such as Reuters' Instinet, Island ECN and Bloomberg TradeBook, run by the parent of Bloomberg News -- are faster, cheaper and less fallible than human brokers, their proponents say. ECNs, though, have only operated during a bull market; as yet, their performance hasn't been tested by a crash.
Specialists point out that in October 1987, when they bought more than $700 million in stocks in the face of the ''Black Monday'' rout, some Nasdaq market-makers wouldn't answer their telephones when customers called to sell. They say ECNs may prove no better.
ECN boosters, undeterred, say, online investors soon will be trading stocks 24 hours a day, not the mere six-and-a-half the NYSE is open for business today. Most people won't care about the market mechanics any more than they care how their PCs work, say proponents. All they'll want is the best price -- whenever they want to trade.
Trading floors will soon be ''obsolete,'' says Frank Zarb, chairman of the National Association of Securities Dealers, parent of the electronic Nasdaq exchange. The change will produce ''the mother of all Big Bangs,'' he says, eclipsing what occurred when the U.K. deregulated financial markets and the London Stock Exchange abandoned its trading floor.
Faster, Cheaper
''Faster, better, cheaper -- that's what the investor wants,'' says Kenneth Pasternak, chief executive of Knight/Trimark Group Inc., the Nasdaq's largest market-maker. ''The only exchanges that have succeeded are the ones that have moved onto an electronic platform.''
So far, ECNs have grabbed just 4 percent of the trading in listed stocks, according to a report by brokers Salomon Smith Barney, in part because of an NYSE rule that protects the exchange's business. Securities & Exchange Commission Chairman Arthur Levitt is pushing to drop that standard, known as Rule 390, and throw open the NYSE to competition from ECNs.
''We have a lot to be worried about,'' says Charles J. Bocklett III, senior member at Bocklett & Co., which handles 80 stocks and is one of the NYSE's smaller specialists.
Since 1986, their number has shrunk by half, from 55 to 27, as smaller family-run firms merged or were sold. Hedging against an uncertain future, specialists Spear, Leeds & Kellogg helped establish their own ECN amid expectations that fewer than 10 of their number will be around 10 years from now.
Specialists have been strained by the sheer volume of trading on the NYSE. A decade ago, about 162 million shares, on average, changed hands each day on the Big Board. Today, that figure is 782 million. The NYSE requires specialists to hold only enough capital to buy 25,000 shares of each company whose stock they handle, a pittance in today's markets.
Moreover, thenine-year bull market has actually impaired specialists' ability to stabilize prices. The market value of companies has simply grown too large. While specialists bought $700 million in stock propping up shares during the 1987 crash, that figure would amount to $3.5 billion today, given the five- fold surge in the Dow industrials.
Evolving Market
The three largest firms of specialists, which together handle more than 1,000 stocks, have combined capital of less than $1 billion.
''The specialists are vastly undercapitalized, and one of the big fears is that they won't have the resources to ride through a major downturn in the markets,'' says Mitchel Abolafia, a professor at the State University of New York who has studied the specialists. ''They can be simply knocked out of the box.''
While some small specialist firms have sought buyers, LaBranche, the third-biggest specialist, in August took the bold step of going public, the first specialist todo so. The stock, priced at $14, has slid a point to about $13.
''Everyone is calling us dinosaurs,'' says Michael LaBranche, the 44-year-old chief executive whose great- grandfather founded the firm in 1924. ''But no computer -- no ECN -- could do what we do. Computers don't have human judgment.''
Among the NYSE's most vocal critics are investors and independent traders, people like Louis Navellier, a Reno, Nevada, money manager.
''The marketplace is evolving away from these guys,'' says the president of Navellier & Associates Inc., which prefers to trade over ECNs. ''You can't stop progress.''
Grasso, 53, must maneuver between calls for change and the demands of the 1,315 seat-holding men and 51 women who pour through the NYSE's neoclassical facade in lower Manhattan each morning to trade on the floor.
Like Anthony Corso, many of the 480 specialists and floor brokers got their jobs through friends or family connections. Personal relationships play a big roleon the floor, where a man's word is his bond. The NYSE floor may be an old boys' club, but members know they can't succeed without trusting one another.
Corso's Day
For Corso, a Brooklyn native who followed his father onto the exchange floor, the day begins at 8 a.m. at LaBranche's offices at One Exchange Place on Broadway across from the NYSE. After meeting with his team of traders, he dons his trader's jacket with a mesh back designed to keep him from sweating through to his pin-point blue oxford shirt. Sleeves rolled up, he pins badge 866 to his left lapel and heads to the floor.
Built like the Fordham University tight-end he once was, Corso is LaBranche's ''shouter,'' the man his firm calls in to control a crowd of anxious buyers or sellers. Aside from handling trades in the likes of Lucent, Williams Communications Group and Tribune Co., he heads his firm's seven-man ''SWAT team,'' which steps in to cope with ''situations'' like new listings ora stock that suddenly surges or plunges.
By 9:25, orders are flowing into SuperDOT, the exchange's electronic order delivery network. SuperDOT -- DOT stands for ''designated order turnaround'' --- routes nine out of every 10 orders to the specialists. The system cost $2 billion and the payoff is the capability to handle 2 billion stock transactions a day. In 1998, 150.1 billion shares went through the system.
Specialists, on average, take 22 seconds to execute a trade. That seems fast down on the floor, but is downright plodding by ECN standards. Island ECN takes just 3/1000th of a second to process an order, according to William Sterling, its chief technology officer.
Abuses?
For Corso, surrounded by computer screens, the one in front of him inside a teller-style window is key to his job. This is the ''Display Book'' where Corso sees every buy and sell order and gets a good picture of the demand for his stock -- an edge any trader would covet.
Other floor brokers depend on Corso for information. If a broker asks for ''a look,'' Corso might disclose that Goldman Sachs Group Inc. has been ''working'' a big sell order for a client, or that Lehman Brothers Inc. bought Lucent yesterday, suggesting more buys ahead.
Specialists say that this flow of information greases the wheels of commerce and helps the marketplace determine a true price for a stock, something with which ECN proponents take issue.
''Anytime you have that kind of information it's going to be abusive,'' says Concannon at Island. Even so, allegations of improper trading on the Big Board floor tend to be rare.
On the floor, Corso is expected to step in when there's an imbalance of buy and sell orders. If the best bid for Lucent is 62 and the best offer is 62 1/4, Corso might bid 62 1/16 and offer 62 1/8 to narrow the spread, displaying prices on the screen above his head.
This intervention, which helps make the NYSE less volatile than the Nasdaq, is what specialists portray as ''price improvement'' and ''liquidity.'' About 97 percent of the trades on the NYSE are done within 1/16th -- a ''teenie'' or a ''steenth,'' in floor lingo -- of the previous trade, according to the NYSE.
Imbalances
Now, facing a massive imbalance of Tyco sell orders as the 9:30 bell approaches, LaBranche decides not to open trading in the stock until it can determine a ''fair'' price. Corso dashes around buying Tyco. If LaBranche may make $5 million some years trading Tyco for its own account, today it pays for its franchise.
By 10:09, when Tyco opens, the stock is down 2 to 93 1/2. LaBranche buy orders prevented an even steeper decline. Corso helps hold the price a few minutes, trying to give buyers and sellers time to sort rumor from fact.
Inside 10 minutes, he is down almost $570,000 in Tyco. About two dozen brokers are gathered in front of him, many holding sell orders. Almost all are shouting. Tyco is still dropping -- 93, 92 3/4, 92 7/16, 92. Suddenly, at 10:25 a.m., it falls to 89 1/2.
''Everybody, quiet down!'' Corso bellows. He doesn't look it but Corso is nervous, worried Tyco might plunge another 10 points, maybe more. LaBranche, obliged to maintain a ''fair and orderly market,'' may be buying all the way down.
In a free market, or on the electronic Nasdaq market, Tyco would have tumbled even faster. But Corso keeps leaning against the wind. Few people may realize it but the world's largest stock exchange -- the temple of American capitalism -- is in reality a partly managed market.
Michael LaBranche has been watching from the edge of the crowd. At this point his firm has spent more than $10 million propping up Tyco. ''See, we can't walk away from it,'' says LaBranche. ''We can't turn the switch off. This is our obligation.''
No Breaks
LaBranche has talked with Tyco executives about what's happening on the floor. For NYSE-listedcompanies, specialists are a source of market intelligence in a world where executives are measured by their company's stock performance.
Then, at 10:45 a.m., Tyco begins ''getting its legs.'' The stock has bounced off its low of 83 to 87, then rebounds to 89 1/2. Buyers are stepping up.
''Are we done? Can I take a break?'' Corso says, his face red and voice rasping.
Today's trading in Tyco, however, doesn't allow for a break. An hour later, Corso is still at it, managing what he calls ''controlled chaos'' and hoping LaBranche can make back a ''teenie'' here, and 1/8th there. Finally, he pushes his way back through the crowd.
On this day, the laptop at Corso's elbow shows he's lost money. LaBranche spent millions of dollars and now is holding 420,000 Tyco shares. (Tyco stock split two-for-one on Oct. 21. The stock was lately trading at around 41.)
Some LaBranche specialists fared better as Tyco was being hammered. On the other side of the floor, Christopher Smith traded profitably in AT&T, easing the drubbing LaBranche & Co. took in Tyco.
Whatever the rigors of the trading floor, LaBranche's 34 managing directors are well compensated, earning an average of $1.7 million last year.
By 4 p.m., six and a half hours after the market's opening, the exchange floor is slippery with pink and white trading tickets, Dipsy Doodle bags, gum wrappers and foam cups. Corso's mesh trader's jacket hasn't prevented sweat from soaking his shirt.
''You just try to survive,'' he says, the color drained from his face. ''It's like filling sandbags against a flood.'' |
