About 65 traders had a private meeting with Nasdaq officials last month at New York's Marriott Financial Center. The officials stood before the crowd of market makers with a strange air of optimism and resignation.
The crowd came seeking the truth: Will the integrated order-delivery and execution system proposed by the National Association of Securities Dealers bore a big, gaping hole in their bottom line?
The mood at the Marriott was slightly surreal. Cordial but tense. No shouting matches, no brawls, just some bruised egos and professionals worried about the future.
OptiMark
Earlier in the month, diplomacy seemed to fly out the window, leaving many market makers seething over the atmosphere of secrecy that preceded Nasdaq's agreement in principle with OptiMark Technologies to fuse OptiMark's electronic crossing network with Nasdaq.
Worse, some market makers said stitching these two systems together would have horrible consequences.
"The OptiMark agreement is a total abomination," snapped Kenneth Pasternak, president and chief executive at Jersey City-based wholesaler Knight Securities, in an interview days after attending the meeting. "Market makers are totally against it."
Like the voluntary limit-order file sponsored by the NASD if it is approved, the separate OptiMark link in the NASD's plan for a new trading platform originally dubbed Next Nasdaq could disintermediate much of the order-execution process.
That would allow, for example, institutional and retail customers to anonymously, and without disclosure, search out the best prices for their orders using unique satisfaction profiles. In fact, OptiMark promises to aggregate and cross buyers and sellers every 90 seconds using algorithms and powerful computing that only recently dropped sufficiently in price to make its utilization cost effective [see Trading Strategies, page 84].
Still, OptiMark has not received the same serious public scrutiny as other trading systems did in the past, partly because only a handful of people seriously understand how it works, raising fears that it may be unsatisfactory like a well-marketed damp squib, according to some industry pros.
What's more, some traders are worried that Nasdaq will exercise warrants enabling it to acquire an ownership stake in a system that could accelerate Nasdaq's drift towards an order-driven agency market.
Interviews
In other interviews days after the meeting, which was sponsored by the Security Traders Association, feelings among traders about the NASD's proposals were running deep. "If we give access to institutions, then what in hell do they need us for anymore, except when they can't get anything done," said Bill Whalen, head of Nasdaq trading at New York-based Furman Selz. "Institutions can now become our competitors."
Another Nasdaq trader, Fred Ott of Neidiger Tucker in Denver, said, "the old traders, guys that have been in the business for 30 years, feel these proposals are a slap in the face."
STA President John Tognino was more diplomatic, but did not mince his words either. "The concerns [of traders] are genuine and center on whether the NASD, as a self-regulator, should be allowed to develop a voluntary, consolidated limit-order book that could become a defacto [mandatory] limit-order book," he said.
Nasdaq was represented at the meeting by its president, Alfred Berkeley, and executive vice president J. Patrick Campbell. On the NASD side was chief operating officer Rick Ketchum, senior vice president of trading and market services Bill Broka, and senior vice president of NASD market operations Glen Shipway. They spent the meeting taking tough questions and selling Nasdaq's latest proposals with undeniable courage.
No, this was not an easy sell. But some parts are easier to sell than others. For one thing, Nasdaq proposes to provide market makers relief, however clunkily, from orders sent to their desks by firms somehow seeking to manipulate the market. The plans gives traders up to 17 seconds to adjust, accept, decline or do nothing on orders up to 5,000 shares, and up to 32 seconds on orders of 5,000 shares or more.
For another, few Nasdaq market makers question the proposal to scrap SOES and SelectNet and replace them with a single entry point for order executions and trade negotiation. The past 12 months have been a living nightmare for traders whose pocketbooks depend on these systems.
That's because the SOES and SelectNet windows allow a trader to access another trader's quote almost simultaneously on SOES and SelectNet, subjecting that latter trader to an unintended double liability. The problem is further complicated when traders are working a combination of telephone and SOES and SelectNet orders.
Traders, however, have hard feelings about an integrated order-delivery system stitched to OptiMark. Many resent the fundamental shift they see taking place in Nasdaq, implemented by the NASD under Securities and Exchange Commission prodding.
Reform Mode
With the fires of two government investigations and a class-action lawsuit settlement against Nasdaq still smoldering, Nasdaq is in a reform mode. But some traders think it is moving too far, too fast. "It makes me very queasy," said Dan Franks, an equity trading boss at Scott & Stringfellow in Richmond, Va.
Nasdaq is traveling on the road built by the order handling rules, leading to a marketplace partly conceived in private meetings of its Quality of Markets Committee. The Promised Land is pools of liquidity, electronically interacting to match customers' best bids and offers on a price and time-priority basis.
Stretching the biblical metaphor, could Nasdaq be destined to wander aimlessly in the desert? That's open question, but some traders do think Nasdaq is traveling carelessly.
"I am not against technology," Franks explained, "but we need to slow down first on rule changes until the current changes in our market have worked their way through the system and been tested in a variety of markets."
Some traders on the institutional buyside have a different view. "Nasdaq is listening to the institutional investors," said Harold Bradley, head of trading at Kansas City-based American Century. "It is trying to move its market closer to the point of purchase, which is what these institutional investors have said in survey after survey. They want anonymity. They want control."
Bradley is very close to the major developments now swirling about Nasdaq. He is a member of Nasdaq's Quality of Markets Committee and American Century is an investor in OptiMark.
Fait Accompli?
Although the NASD new-look trading platform is hardly a fait accompli, and must first be approved by the SEC, some market makers have concluded the current plan could hurt their business.
When E.E. "Buzzy" Geduld, president of Jersey City-based wholesaler Herzog, Heine Geduld, protested at the Marriott meeting that the NASD proposals if enacted would compete with market makers, the NASD's Ketchum brushed his concern aside with a sly dig that payment-for-order-flow arrangements today give market makers an unfair competitive advantage over others.
Leveling the playing field was repeated ad nausea by Nasdaq officials at the meeting, according to one participant, a medium-sized, market maker based in the New York area.
Nasdaq officials at the meeting said Nasdaq wants to share revenues generated on the voluntary limit-order file with firms designated as primary market makers. They did not make it exactly clear how that revenue-sharing arrangement would work, but the aforementioned market maker interpreted the comments as good news for medium-sized firms and bad news for wholesale-trading powerhouses.
The trader said the proposal could give his firm an opportunity to pick up business previously monopolized by several large wholesalers with payment-for-order-flow arrangements.
At the moment, Nasdaq is aiming to tighten primary market-making standards. While these currently set the minimum frequency market makers must be on the best bid and offer in a stock, and provide a short-sale rule exemption, among other requirements, the potential rewards are wonderful, said the same trader with the medium-sized New York-area firm.
"The retail customer will pay a tiny, de minimus commission to his broker, but the customer will still save money on price improvement," the trader said. "The broker, in turn, will send the order to me or put it directly in the book, and I will be guaranteed a proportion of the fee for providing liquidity." Primary market-making status is also required by market makers that want to sponsor institutional access to the new system.
However, the STA's Tognino said it was premature to draw conclusions about revenue-sharing arrangements.
In fact, it is too early to count who the real winners and losers would be if Nasdaq ploughs ahead with its new trading-platform plan. Conceivably, Instinet and POSIT, as well as market makers who duke it out for order flow today, may not have to do so in the future. Sadly or not, order flow may simply bypass them.
American Century's Bradley is not worried. "These systems are based on a hugely flawed market structure," he said. "It took somebody to come down and threaten the existing infrastructure and expose it as a fraud."
As traders dissolved gloomily after the Marriott meeting into the Manhattan evening, snatches of overheard conversation told another story. Some market makers are on a slow boil.
