**OT** Move Over, NYSE? OptiMark System Creating a Buzz
By TOM PETRUNO, 4/12/98
latimes.com
Twenty-three years ago, Congress ordered the U.S. securities industry
to move toward a "national market system"--a unified market in
which competition would generate the best prices for stocks, market
information would be readily available to all investors and securities dealers
would always place the interests of their customers first.
Are we there yet? Bill Lupien is betting $110 million of his and other
people's money that we aren't there--but that he holds the key to finally
creating the fair, open and efficient national market system that Congress
wanted.
Lupien's new OptiMark Technologies Inc. trading system is generating a
major buzz on Wall Street. Operated by a supercom()puter,
OptiMark promises to continuously take in buy and sell orders for stocks
from both institutional and individual investors, match them instantaneously at
the investors' preferred prices and execute the trades--all in total secrecy,
except for reporting each transaction to the market once completed, for all
to see the price and size of the trade.
The Pacific Exchange (formerly the Pacific Stock Exchange) was the first
to decide to tie itself to OptiMark. The Nasdaq Stock Market and the
Chicago Board Options Exchange also now are on board, and IBM Corp.
and Dow Jones & Co. have signed on as strategic partners.
Most important, Lupien says he has so far persuaded more than half of
the 220 largest U.S. institutional investors, plus 60 broker-dealers, to give
his system a try when it is launched, tentatively around Labor Day.
Yet OptiMark's success is far from assured. Many big investors,
although intrigued byOptiMark's possibilities, wonder if it can deliver. "This
is either going to be the greatest thing since cracked nuts, or the next Edsel,"
said one institutional investor, mixing his metaphors but making the same
basic point expressed by others.
For small investors, who have watched the Nasdaq Stock Market finally
be beaten into submission over the last year (23 years late, by Congress'
watch) in terms of giving individuals a fairer shot at better stock prices,
OptiMark's development is worth watching at least.
* * *
What does OptiMark offer that current trading systems don't?
Computers, after all, now facilitate most market systems; that's how we've
come to trade upward of 500 million shares daily on both the New York
Stock Exchange() and Nasdaq--numbers that seemed too large even
to contemplate in the early 1970s.
Lupien's novel idea, developed with a rocket-scientist-type named Terry
Rickard, is to give a supercomputer near total control of the process of
trading, but only after investors have entered buy or sell orders that
specifically instruct the computer where the investors' optimal trades would
be.
Whereas modern (and reviled) "program" trading automatically triggers
buy or sell orders based solely on market swings, the OptiMark system
seeks to match buyers and sellers if they can be matched.
Today, that job of putting buyers and sellers together is performed by the
stock exchange's individual "specialists" (on the exchange floors), by
broker-dealers (in the Nasdaq market) or by automated systems such as
Instinet that allow big investors to trade among themselves in large blocks of
stock.
But Lupien, who was a Pacific Exchange specialist from 1965 to 1982,
then Instinet's CEO from 1983-88, contends that all of those systems have
drawbacks that keep them from delivering the best possible national market
to investors.
OptiMark, he said, "is a change in the concept" of trading--maybe the
biggest change in 200 years, his marketing people suggest, with typical
marketing chutzpah.
* * *
Here's how OptiMark works: The system's supercomputer operates
during normal trading hours, during which time institutional investors can
send their buy and sell orders directly to the system, rather than to the
NYSE, Nasdaq or other markets.
The key to the OptiMark system is that investors aren't limited to
indicating a single price for a single block of stock either to buy or sell.
Instead, an investor can design a changeable "profile" for each stock,
indicating willingness to trade specific volumes at specific prices--for
example, no shares at $51.50, 10,000 shares at $51, 20,000 at $50.50 and
30,000 at $50.
Most significant, those profiles are known only to the investor entering
them and to the OptiMark supercomputer. No one can see into the system,
including OptiMark's own people. (Accounting firm Deloitte & Touche has
been hired to certify the system's security.)
Those guarantees of investor anonymity and nondisclosure of order sizes
(except within the market itself) are two of OptiMark's principal drawing
cards. Why? Put yourself in the place of a mutual fund manager who on any
given day may be buying tens of thousands of shares or selling tens of
thousands of shares, or both.
If you enter an order into the market to buy 50,000 shares of XYZ
Corp., you are immediately showing your hand to others in the market.
What happens then? Other investors, and dealers, may push up the price of
the stock for no other reason except that they know you are interested in
buying.
That "market impact" effect of your order may not be significant if the
stock is a highly liquid issue such as IBM. But for the majority of
stocks--most issues, after all, aren't big stocks--market impact is a major
risk for large investors.
Various studies have estimated that market impact in trading can cost big
investors as much as 10 times whatever they're shelling out in commissions
for a given trade.
Trading within the OptiMark system is supposed to eliminate the
market-impact problem because only the supercomputer knows what kind
of orders are in the market, and its only job is to match those orders
according to the profiles investors enter. To put it another way, the
computer's only job is to try to make everybody as happy as possible, in the
context of the prices they've indicated they're willing to pay.
Also, unlike other electronic matching systems that put big investors'
orders together infrequently during the day, OptiMark will run in 90-second
cycles. That, Lupien says, will give the computer time to look at all of the
entered stock profiles, check other competing markets (such as the NYSE
and Nasdaq) for better prices than what the profiles show, and execute
trades at the optimal prices available, wherever they are.
Small investors, although unable to enter their own profiles into the
OptiMark system, nonetheless can benefit from the system, because it will
bunch together smaller orders seeking the same price into single orders large
enough to match with institutions', Lupien said.
That is part of what appealed to the Pacific Exchange when it decided to
become OptiMark's "introducing exchange" for equities, said Pacific
Exchange Chairman Robert Greber.
If Congress' mandate from 1975 is to be taken seriously, then "the ideal
is to find a system that lets institutions do what they want and also allows
individuals to participate along with them," Greber said.
It's important to note that while the sizes and prices of orders in the
OptiMark system are cloaked, each final trade is not. All investors will see
the results of each OptiMark trade printed on the market "tape," just as each
trade now, wherever it occurs, appears on that tape--which tells the market
what's happening with prices and volume.
Lupien, whose privately held company is based near his ranch in
Durango, Colo., says the most important role that OptiMark could play is in
increasing overall market liquidity--which then could dampen stocks' price
volatility.
How? Because if large investors know that they won't be penalized (by
triggering sharp price moves) for simply indicating that they're interested in
trading a substantial number of shares, the market at any moment could
become much larger and more liquid, he said.
"If it does everything it promises, we're going to have another system
competing [to create] liquidity, and we like that," said Scott Shellhamer,
head of equity trading at the PBHG Funds.
"We're hopeful that this will develop," added Gus Sauter, manager of
Vanguard Group's giant Index 500 stock fund.
* * *
Yet even as many institutional investors sign up to trade on OptiMark,
skepticism is high. Lupien needs a critical mass of active investors when
trading begins, or OptiMark could flop.
Some traders who have seen the system say it's too complex and that
most investors won't have the time to create and continually tweak their
stock profiles. "Too much clicking and dragging" on a computer screen, one
trader said.
Others rebut that. "A profile can be as simple or as [complex] as you
want to make it," Shellhamer said.
While Nasdaq has embraced OptiMark, the NYSE has not.
Is OptiMark a competitive threat? Lupien insists that his system is not
designed to eat Wall Street as we know it. OptiMark is not a dealer--just a
service, charging per-trade fees. Human traders will still be needed to advise
investors; broker-dealers and specialists will still be needed to add their
capital into the mix, assisting clients in buying or selling.
Still, Lupien admits: "We've just bet a hell of a lot of money . . . that this
is the only way people are going to want to trade."
* * *
Tom Petruno can be reached at tom.petruno@latimes.com
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