The debate over Arthur Levitt's career as chairman of the Securities and Exchange Commission begins in earnest on June 5, 2003, when his current term ends. If he serves out his term, he will have become the longest-serving chairman of the SEC.
He will end up as a hero, a has-been or as a mediocre advocate of market reform. His legacy is not assured. But his place at the center of the most fascinating and challenging era in securities trading is guaranteed.
A global stock market that allows investors to trade around the clock in ordinary shares over high-speed digital networks is forming. Europe, Asia and the Pacific Rim are emerging as big-boned models of market efficiency.
Levitt, the dapper securities markets reform advocate, could play a leading role in the coming global capital marketplace. But with foreign competition percolating, regulators in Washington are uneasy.
Can the U.S. retain its position as the world's preeminent venue for stock trading in 2003? Levitt knows there is a very real threat of stumbling badly. And he is making no secret why the U.S. securities markets need to be overhauled.
"We have an opportunity today that I don't think we'll have again in our lifetime – to realize the vision for a true national market system – one that embraces our future as much as it honors our past," Levitt said in a speech at Columbia Law School in New York.
At stake is more than Levitt's legacy. The foundations of the U.S. stock markets are shifting with the weight of an alphabet soup of trading systems and execution centers.
"We are moving into an environment that steadily fragments," said Richard Ketchum, president of the National Association of Securities Dealers at the recent STA Conference in Palm Desert, Calif. "It looks and feels like the Middle Ages of securities trading where various fiefdoms are closely held by a small number of players, with other players having lesser or different access."
The solution? Levitt wants more centralized stock trading though he does not want competition eliminated. "We cannot ignore the possibility that aggregating limit orders across markets, and rewarding those that post the best price first, may produce better prices for customers," he said in a speech to the Economic Club of New York.
Achieving that goal is problematic. But the NASD, striving to create a venue for limit order trading, came up with its super montage proposal. As currently constituted, the dealers who run Nasdaq, as well as the ECNs, would essentially control the proposed system. ECNs are not as likely to support a potential competitor. Nonetheless, the NASD's proposal allows both groups to become "quoting participants," meaning orders for the montage system would be sent to them first.
The last effort to impose a limit order book collapsed over dealers' objections. They complained that customers' limit orders would bypass them. That system was a more extensive central limit order book.
The montage system is different. Dealers could voluntarily send multiple agency and principal orders anonymously or with a market maker attribution at multiple price levels. Nasdaq said it would redesign its dealer workstations to incorporate a window for the montage at the top. Two other windows underneath would carry the current workstation features, in addition to a designator for the size of orders sent to the montage system.
The top window, known as the Order Display Window, would show the inside market on Nasdaq, followed by two price levels below. A separate reserve size feature would replenish a participant's displayed size order once that order is decremented to zero.
While the montage responds to Levitt's call for more centralized markets it does have a drawback, according to critics. ECNs would see their current business model crimped. That flies in the face of the type of competition Levitt might see as necessary.
"Where is the redeeming social benefit of the super montage?," said Kevin Foley, president of Bloomberg Tradebook, "Nasdaq does not mutualize risk and guarantee the other side of a trade like other ECNs."
ECNs come out looking wounded under the super montage proposal, which was sent to the SEC for publication in the Federal Register. But ECNs aren't about to switch off the lights.
"I see ECNs as the small technology boutiques of financial services," said Arthur Pacheco, president of STRIKE Technologies at the STA's Palm Desert conference. "They are small and they don't have huge infrastructures. They are flexible and innovative and technological change will probably be driven by these small boutiques."
ECNs could see some drying up of revenue streams under the super montage proposal. The planned facility would effectively operate as an ECN sponsored by Nasdaq. At the same time, Levitt has publicly stated that he thinks ECN access fees for non-subscribers are unfair. What that ultimately means is not clear.
Dealers, on the other hand, stand to reap transaction revenues by providing liquidity to the montage system. So do ECNs but they are unlikely to have the same enthusiasm as dealers for sending limit orders to a competitor. Dealers would also be empowered to automatically execute agency and principal orders in a consolidated SelectNet and SOES system.
One ECN executive, speaking on the condition of anonymity, sees trouble brewing. He said current ECN subscribers will be tempted to develop pipelines to allow them to access ECNs through a gateway built for non-subscribers.
Already, the talk sounds a little like what Levitt does not have in mind. "What we need is a central limit order book for equity trades," said Peter Jenkins, head of equity trading Scudder Kemper Investments in New York, stressing that he hasn't fully studied the super montage proposal. "[The institutions] called for a CLOB in the past and nothing has changed."
Dealers, including industry activist Bernard Madoff, a principal at Bernard L. Madoff Investment Securities, have so far supported the super montage proposal. Lee Korins, the president of the STA, said that on the surface the proposal was a step in the right direction.
"The problem is Nasdaq keeps coming up with the proposal of the year and then the next day its network shuts down," said Korins, referring to an outage on Nasdaq in early October. "The question is, has Nasdaq the technology platform to pull [the proposal] off?"
Nasdaq and the NYSE are planning to fight competitive technological currents with deep infusions of capital, having taken steps on the road to becoming for-profit companies. Both exchanges see tantalizing franchise opportunities overseas. The SEC is not standing in the way.
Levitt noted, however, in his Columbia Law School speech, that "progress has sometimes been frustrated by narrow interests and that's when it's been necessary to invoke pragmatic regulation."
His legacy may not please everyone.
