Statistics released by Nasdaq market makers in the first round of best execution reports proved to be a mixed bag, but some desks stood out. Under the Securities and Exchange Commission's Rule 11Ac1-5, all Nasdaq dealers are required to provide their customers with certain standard measures of execution quality each month. The data, designed to assist brokers making routing decisions, will also be used by regulators.

The most watched measure is the effective spread. It is a calculation of the difference between an execution price and the mid-point of the NBBO. Based on small trades made in Nasdaq 100 stocks by the 50 largest dealers last October, most spreads ranged from 1.5 cents to 2.5 cents.

Both Prudential Securities and Bernard L. Madoff Investment Securities stood out with extremely low [good] postings of 0.46 cents and 0.98 cents, respectively. Less impressive numbers came from Crowell Weedon with 4.86 cents, and NDB Capital Markets with 3.28 cents.

Regional shops tended to provide the slowest executions. Crowell Weedon; Miller, Johnson; Morgan Keegan; Wachovia Securities; Ladenburg Thalman and Advest all took, on average, eight seconds to 27 seconds to fill their orders. Big shops such as Bear Stearns and Morgan Stanley tended to group at the low end with one, two or three second executions.

The new figures lead analysts to predict a winnowing of inferior dealers. "This will only accelerate the industry consolidation," said Ted Karn, president of Market Systems Inc., a consultant that focuses on best execution.

The race among ECNs to dominate trading in Nasdaq stocks could speed up in the coming months as marriage partners Archipelago and Redibook make up ground on industry leader Instinet and, the No. 2, Island.

The partners combined would account for some eight percent of Nasdaq share volume, compared with about 11.6 percent on Instinet, and 10.4 percent on Island. (The volume is based on Nasdaq data.)

"I don't think the Archipelago and Redi merger presents that big of a threat since they still match less than Island or Instinet on a combined basis," said Greg Smith, an analyst at J.P. Morgan. "However, more mergers in the ECN space could definitely tip the scales and start to threaten the primary markets of Nasdaq and the Big Board," he added.

Once the merger is completed, the Redi system will focus on Nasdaq executions, while the Archipelago system will likely be used for matching listed stocks, according to TowerGroup in Needham, Ma.

(Archipelago has also joined forces with the Pacific Exchange to operate as its trading arm.) Goldman is the largest stakeholder in the combined Archipelago and Redi entity. It owns 12 percent in Archipelago, and up to 18 percent in Redi.

Separately, Tower contended that, as decimal pricing reduces the liquidity provided by market makers and as alternative sources of liquidity grow, chances of executions occuring on Nasdaq's planned SuperMontage will diminish.

After being slapped with the largest fine in the history of the American Stock Exchange, Spear, Leeds & Kellogg is scrambling to clean up its floor act.

On top of a $1 million judgement, Spear, Leeds has been ordered by the Amex to conduct a review of the supervision of its clearance and specialist operations on the floor. It must also adopt supervisory procedures for certain business units.

Spear, Leeds is paying the price for inadequately monitoring its head of clearance operations at the exchange in the mid-90s, Pasquale Schettino.

The rogue trader credited profitable, but "unlawful" stock and options trades to the account of a Spear, Leeds customer. Schettino, himself, was fined $100,000 in 1999 and barred from the industry.

The Amex apparently decided that Spear, Leeds, the largest stock and options specialist at the Amex, did nothing to stop him.

Notably, Spear, Leeds failed to investigate Schettino's activities and did not maintain or enforce any written procedures. The bourse is miffed that Spear, Leeds failed to heed its advice to restrict Schettino's access to the floor during its investigation.

Goldman Sachs, Spear, Leeds' parent, states the two groups did cooperate with the Amex in its investigation. A spokesperson for Goldman, however, declined to discuss its time frame for complying with the Amex edict.

The average trader has the same wishes for 2002 as the average American: End international terrorism and prevent a repeat of Sept. 11.

Lower down on the New Year wish list are issues pertinent to how traders earn their daily bread – regulations, ECN access fees, Nasdaq commissions and technology.

John Giesea, president of the Security Traders Association, is looking forward to finally achieving a reduction in Section 31(a) fees.

"We would also like to see a successful implementation of the SuperMontage and the elimination of subpenny trading," he added. "At the end of the year, we [the STA] would like to be able to look back and say that we have had greater impact in dealing with the Securities and Exchange Commission by virtue of its new chairman Harvey Pitt."

A Nasdaq head trader, who spoke on the condition of anonymity, said that he would like to see the National Association of Securities Dealers provide more clarification about the changes sweeping the marketplace.

"As far as commissions on institutional trading goes," he said, "it shouldn't be like the Wild West. We need a referee."

"We need somebody to tell us what's right and what you can do," he added. "Right now, it's whoever has the best system or the cleverest compliance department that seems to survive."

The trading desk of Gerard Klauer Mattison (GKM) has raised close to $1 million for breast cancer research. The New York-based investment banking firm recently donated the net commissions of its institutional trading business for one day. Proceeds went to the Susan G. Komen Breast Cancer Foundation.

"With the exception of the Race for the Cure, which usually raises about $1.5 million," said Molly McDonough, a spokeswoman for the Greater New York City Komen affiliate, "the Gerard Klauer event is the largest one day fundraiser that we have."

GKM has some 50 listed and Nasdaq traders who are based in New York as well as in its satellite offices in Boston and Chicago.

On hand for the benefit was Michael Beneson, GKM's director of institutional equity sales, and CNBC anchor Bonnie Behrend. Twenty-five percent of the money was earmarked for breast cancer research projects. The remaining funds will be dispersed to Komen affiliates in New York City, Los Angeles, Boston, Chicago and San Francisco.

The money will subsidize mammograms and biopsies for financially-strapped women in these cities. It will also be used to promote the importance of early breast cancer detection.

Don't pay your light bill and your electricity is cut off.

But that's not the way it is working in the controversial battle over access fees charged to dealers by electronic communication networks.

One ECN, NexTrade, which operates out of Clearwater, Fla., may or may not cut off some two dozen dealers who are refusing to pay these fees.

Among those facing a complaint by NexTrade are Nasdaq market makers Hill Thomson Magid, Lehman Brothers and Crowell, Weedon & Company, firms that have all filed their own counter-complaints and are in the initial phase of preparing for an NASD arbitration hearing.

"We don't believe we should be charged for something that we didn't order; something that we believe is triggered merely because we used SuperSOES on Nasdaq," according to an attorney for one of the dealers that NexTrade is dunning.

The attorney, who would not be quoted by name, said attorneys for the market makers contend NexTrade's actions amount to a frivolous lawsuit. "In some cases we're talking about bills for hundreds or just a few thousand dollars," he added. "It will cost a hell of a lot more than that to hire attorneys for this," he complained.

The attorney for the market maker noted the irony of the case: NexTrade, obviously fearing the loss of the flow of business, had not cut off many of the market makers from its services even though they were delinquent in payment.

However, he concedes that, although the ECNs want his client to pay, at the same time the flow of business from dealers is critical to the survival of the ECNs.

For NexTrade, survival is a thorny issue. It is one of the three smallest ECNs in terms of its share of Nasdaq trade executions: a negligible 0.2 percent of total volume in recent months, according to Nasdaq statistics.

Several attorneys said they thought the NASD arbitration, which is not expected to be held until sometime this month at the earliest, could set precedents for the continuing controversy over ECN access fees, charges that marker makers believe are unfairly imposed.

"There's no contract or implied contract in using the [NexTrade] ECN," according to George Casey, a partner and co-manager of Nasdaq trading for Crowell, Weedon & Co. "We're confident that our position will be upheld." He noted that using an ECN is, at times, inevitable when a market maker goes through the SuperSOES system.

NexTrade officials declined comment. They said that attorneys in the matter should avoid public statement. They stressed that the arbitration rules bar them from commenting on the issue until it is adjudicated.

"We would be prejudicing the case if we commented," said Daniel Caamano, the attorney for NexTrade, an expanding business in some areas that was hiring new employees last summer.

NexTrade has filed an application to become a stock exchange and a futures exchange. Business, said NexTrade officials in its third quarter report, has been booming. In the quarter ending Sept. 30th, NexTrade reported record profits. The NexTrade ECN is offering 24-hour a day trading through participating broker dealers.

The Security Traders Association, with both market making and ECNs as members, has taken a middle-of-the-road position on this touchy issue, which is being watched closely by much of the industry.

"ECN customers must pay an access fee for the use of a network when they buy or sell securities," the STA said in a prepared statement. "Market makers, on the other hand, have not been permitted to charge fees to ECNs or to other market makers to effect a transaction. This situation creates an inequity that must be addressed."

The organization also said it is against any requirement that forces a market maker to incur a fee in order to satisfy best execution requirements. John Giesea, the new STA president, called on the regulators to clear up the basic "inequity" of access fees. Giesea said that market makers can be charged, but they can't charge their customers. STA officials called on the SEC to clarify when access fees can be imposed. Clarifications are needed, several market participants privately said, because arbitration panels have not been clear.

For example, in late 2000, an NASD resolution panel decided a case in favor of an alternative trading system. It awarded Bloomberg Tradebook some $90,000 plus interest that it had been trying to recover from U.S. Bancorp Piper Jaffray. U.S. Bancorp Piper Jaffray held that Bloomberg's trading practices violated securities regulations.

Cut Off

But Bloomberg noted that the brokerage was paying 1.5 cents per share for several months on transactions in 1997, then ignored the bills, but continued to use the service until it was cut off.

That time the panel sided with Bloomberg. However, late in 1999, another NASD arbitration group largely sided with Knight Securities. Although it required Knight to pay All-Tech, an ECN, some $3,800 with interest for an overdue bill, All-Tech had been asking for close to $600,000.

Although All-Tech was claiming victory, its chief counsel was quoted as saying, "We are somewhat curious how arbitrators arrived at the dollar amount of the award." The access fee is a hot potato that Harvey Pitt, the new SEC chairman, inherited. He inherited the controversy from his predecessor, Arthur Levitt, who criticized access fees and asked his staff to restore "a fair competitive balance between dealers and ECNs." An attorney for one of the market makers said their counter complaint contains many of Levitt's comments. "We're required to obtain best execution, yet we end up using ECNs even though we don't want to," said the attorney for one of the market makers, declining to be quoted by name. An SEC spokesman didn't respond to requests for comment.

Some pundits are predicting dire consequences for Wall Street if the SEC adapts measures it proposed that would curb or even eliminate short selling.

The predictions might be farfetched – and most think shortselling is unlikely to be banned – but how the SEC acts could have major repercussions for trading firms.

The Securities and Exchange Commission knows the territory. Short selling is sometimes controversial. But it is perfectly legal and, generally, it is used sensibly by many investors.

It is a practice in which an investor borrows and then sells stock, hoping he can buy the shares back later at a lower price and then repay' the lending broker. The investor makes a profit if the share price is lower, a loss if it is higher.

Whether a profit or loss, the rules that govern short selling could get overhauled if the SEC adapts some of the measures it proposed in late 1999. And the regulators are closely watching how short sales are used.

In the current bear market, short sellers are an easy target. "Short selling is often viewed as burning the flag," said Joel Milazzo, an institutional trader for Raymond James. "It's probably something you do not want to mention to your friends."

When short selling was introduced to the anything-goes Dutch stock market in the 1600s, it did not take long until the government outlawed the practice. Whenever there is a bear market, short sellers are an easy target.

This was certainly the case during the bear market of the early 1930s. With stocks down more than 80 percent, short sellers became an object of scorn.

And there were certainly many examples of abuses. One of the most notorious was Albert Wiggin, the CEO of Chase National Bank. In the summer of 1929, he shorted 42,000 shares of Chase stock. True, it was a shrewd business decision. But it ultimately backfired, as Wall Street would be under intense scrutiny for decades.

The result was wide scale federal securities law reforms. In the Securities Exchange Act of 1934, Congress legislated clause 10(a), which gave the SEC regulatory powers over short selling. In it, short selling was defined as the sale of a security that the seller does not own or that the seller owns but does not deliver.

However, it was not until 1937 – after another big fall in the market – that the SEC used its powers under 10(a) and drafted 10(a)-1. It instituted the so-called plus tick and zero-plus tick rules, which apply to listed stock exchanges. The SEC believed that the rules would prevent undue pressure on stock prices or even manipulation.

As the memories of the Depression receded, the SEC began to investigate the effectiveness of the short sale rules. In 1963, the SEC conducted a study that indicated that the volume of short selling did increase in falling markets. Then again, the short sale rules were ineffective in preventing the problems that the rules were meant to prevent. But the studies were tentative, because data collection for short selling was inadequate.

Thirteen years later, the SEC published another study. Again, it complained about inadequate data collection. The SEC proposed a temporary suspension of the short sale rules, but it was abandoned in 1980.

In 1991, the House Committee on Government Operations published its own report on short selling. Basically, it concluded that the short sales rules were confusing and ineffective. Interestingly enough, the study said that short selling was actually beneficial to securities markets.

The latest statement on short selling is a concept release published by the SEC in October 1999. In it, the SEC mentions that the "securities markets and short selling activities have changed significantly from the era in which Rule 10a-1 was adopted." The SEC notes that there is more sophisticated investor protection, such as with disclosure requirements and fraud detection systems. Investors have access to virtually the same types of technologies as institutional traders.

"Most agree in the trading community that the short sale rules need to be revisited," said Bernard Madoff, the founder and chairman of Bernard L. Madoff Investment Securities LLC, a listed and Nasdaq market maker.

"While it is unlikely we will see the rules scrapped, I expect changes," Madoff said. "We will need to look at safeguarding against manipulation, and to make sure the regulations are practical for traders that must deal with this on a day-to-day basis."

The SEC has several proposals:

The short sale rule should not apply if a stock is above a threshold price. Example: A short sale is allowed so long as the stock price is currently higher than the previous day's close.

* The short sale rule should not apply to actively traded securities. "With Cisco trading 60 or 70 million shares a day," said Raymond James' Milazzo, "can short sellers realistically drive down such a stock?"

* The short sale rule should not apply to hedging.

* Short selling should be restricted only during certain major world events (say a Sept. 11th tragedy).

* The short sale rules should be eliminated.

As for Dan Weaver, a finance professor at Baruch College, he is worried about the proposed changes. "It could be difficult for less liquid stocks."

A strong believer in the specialist system, he thinks the elimination of the short sale rules would be a hit to the capitalization of specialist firms, especially on the American Stock Exchange. "The [specialist] firms are already on shaky ground," Weaver said. He thinks this would further accelerate the consolidation of the specialist industry.

"I look at liquidity as a shock absorber," Weaver said. "If you have a good one, you do not feel the bumps. By taking out the short sale rule, we reduce the effectiveness of the shock absorber. I think we would see much more volatility."

Kim Bang, president of the Bloomberg Tradebook ECN, thinks the short sale rules are providing preferential treatment to specialists. "I would do away with them," Bang said. "The rules result in prices that are artificial. We should let investors set the price of the stock, not regulation."

Bang points out that if a trader wants to skirt the rules, he certainly can find a way. The transactions usually involve the creation of a married put. Such a put is created prior to or simultaneous with the sale of stock. The transaction is unwound when the shares are returned to the counterparty. In fact, in the SEC concept release, there was concern that these sophisticated transactions may lead to manipulation.

Already, the SEC has been softening its stand on the short sale rules. Last year, the Division of Market Regulation granted a limited exemption to registered market makers and specialists. "Before decimalization, we had to manually input 10 to 20 orders per day because of the short sale rule," Madoff said. "However, within a few days of decimalization, things changed significantly. We were manually inputting 400 per day."

No-Action Letter

So, his firm filed a no-action letter with the SEC. "It was meant not only for us, but for all specialists and market makers that have the same problems with decimalization and short selling," Madoff said.

The SEC exempted the short sale rules for specialists and market markers so long as the short sales were on listed securities and were solely for customer market and limit orders at the national best bid and offer. "We argued that this would not put undue selling pressure on a stock," Madoff said.

But perhaps the most interesting development is the anticipated trading of single security futures. "There is really no difference between selling short and single security futures," Weaver said. "The only difference is that there are no short sale rules for the futures. So it makes the whole argument about the short sale rules moot."

Several months after Rule 11Ac1-5 was introduced, the industry had data on the quality of executions in more than 3,700 listed stocks.

Rule 11Ac1-5, which establishes a common methodology for measuring quality across all market centers, is a positive step for investors. Order flow providers are able to make more informed decisions on where orders are sent. Firms are using the data to make meaningful order routing switches.

After including all order types, order sizes and measures of best execution, there are 292 data points for each security. There are over one million new data points to work with each month, combining the 3,700 listed securities (and the 292 data points per security). On Nasdaq stocks, where the rule kicked in later, comprehensive data should soon provide more perspective. So it would seem, finally, that the best execution debate is over, the order routing puzzle is solved for listed stocks. But is it?

Despite consistent methodologies, formats and data points, there is still a wide range of interpretations and uses of the 11Ac1-5 data. After numerous discussions with industry participants, several conclusions are worth sharing. To begin with, top line market center comparisons have proven themselves meaningless for these reasons:

* Different market centers are trading substantially different sets of securities with different trading characteristics, e.g., trading volumes and prices. These varying characteristics affect Rule 11Ac1-5 results. Hence, accurate inter-market comparisons can only be made at a stock specific level, or, possibly, among stocks with similar trading characteristics.

* Different market centers have different average order sizes. Smaller retail orders will certainly execute faster and will have lower effective spreads than larger institutional orders. Hence, accurate comparisons of market centers must control for order size and also, needless to say, order type.

* Different market centers have different customers. Primary markets accept all customers, be they day-traders, hedge funds or competing dealers. Others can pick and choose at will who to turn on or to shut off. Market center comparisons must account for the nature of the customer base.

Another looming 11Ac1-5 question continues to be: Does the customer care? Is John Q Retail Investor calling his broker dealer screaming, Hey, why are effective spreads in XYZ better on market center A, and you're sending my orders to market center B!' This is probably not a frequent occurrence for the typical broker dealer.

However, with the recently released Rule 11Ac1-6 data, we have taken another step down that road. This rule requires broker dealers to make quarterly reports publicly available, describing their order routing practices, disclosing the venues to which customer orders are routed for execution.

Assuming the retail customer, at some level, does (or will) cares about execution quality, the real question becomes what specifically does the customer care about?' The biggest debate on this issue usually boils down to price versus speed. True, individual investors want a fast execution.

That leaves less time for dealers to play around with the order, right? Oddly, much of the data shows that quicker executions often take place at a greater cost. What will happen if an investor finds out that, if he waited another 10 seconds for his order to be executed, he could have saved $50? These types of analyses are only beginning to surface.

Bottom Line

Finally, for order routers there is always the reality of the P&L. Especially in tight times, profit is the bottom line. Execution quality data has and will continue to be meaningful only in the context of the complete economic picture, such as in areas relative to trading costs and various forms of payment-for-order flow.

In discussing Rule 11Ac1-5 data with order routing customers, a fairly common view is: "All else being equal (trading costs, payment-for-order-flow, etc.)…" effective spreads and net price improvement begin to assume more significance.

Recent developments such as decimalization, the narrowing of spreads, and reduction in payment-for-order flow have leveled the economics across market centers. As a result, execution quality data is beginning to have a more meaningful impact, even though the debate over best execution is certainly not over.

Brett Redfearn is senior vice president of equity business strategy and equity order flow at the American Stock Exchange.

by Michael Steinhardt

(John Wiley & Sons, New York, 289 pages) $29.95

reviewed by Gregory Bresiger

Who says one can't beat indexes? Or that frequent trading causes such

huge costs that one would never expect to generate healthy returns?

Or that there are no consistently great money managers?

Michael Steinhardt was a hell of a hedge fund manager and trader. His career appears to contradict these old saws of investing. The conventional investing wisdom is that most managers aren't worth the obscene fees that they are paid. (These poorly performing managers remind one of the much-ballyhooed experts who claim they can pick the winners on football spreads. One should generally pay attention to their picks, then go the other way).

Steinhardt is obviously an exception to the rule of managers who lag indexes. With only an occasional setback, he shot the lights out between 1967 and 1995. In the early days of block trading, for example, his strategy was flawless. He brags that he was "taking candy from a baby." (page 97)

Steinhardt writes: "In 1969, a trader needed to sell 700,000 shares of Penn Central, a large railroad company in the Northeast at that time. The stock was already in Chapter 11. I was shown a block in the third market. I then checked the New York Stock Exchange market, where it was trading for 77/8. The seller must not have bothered to sufficiently explore the market maker's book on the Big Board because I bought 700,000 shares at 7.

"In fact, the seller seemed relieved to have sold that amount of stock at less than a dollar under the last trade. Meanwhile, I turned around and sold the 700,000 shares at 73/4 to a buyer at another firm." (page 97)

Steinhardt, who became a millionaire by his late 20s, made a half million dollars on this riskless trade that took about eight minutes. Taking candy from a baby? Not exactly. The baby cried and screamed for Steinhardt and his crew to take the candy from him! He was also passing around a lot of candy to people who invested with him.

One dollar invested with his firm at the beginning of this remarkable 28-year run would have been worth $481 at the end of the period. That's versus $19 with a dollar invested in the S&P 500 in the same period.

Put another way, one of Steinhardt's well-heeled clients, Chicago businessman Richard Cooper, put $500,000 into Steinhardt's fund when it opened in the 1960s. Twenty-eight years later, the rich got much richer. Cooper's investment had grown to some $100 million. And those remarkable returns occurred even though Steinhardt had a lousy 1994 (he was down some 30 percent) and even though Steinhardt had failed to see the crash of 1987 coming, despite several obvious danger signs.

But the most impressive part of his performance is how his fund continued to make money during the bear market of 1973-74. Steinhardt says he developed the principle of variant perception, a kind of enlightened investing that led him to make big bets when the market appeared to be in terrible straights.

"The quintessential difference, that which separates disciplined, intensive analysis from bottom fishing," he writes, "is the degree of conviction one can develop in one's views. Reaching a level of understanding that allows one to feel competitively informed well ahead of changes in street views, even anticipating minor stock changes, may justify at times making unpopular investments. They will, however, if proved right, result in a return both from perception change as well as a valuation investment. Nirvana." (page 130)

Difficult Boss

Steinhardt shut his firm in 1995 with a tremendous reputation for strong returns and, we learn late in the book, for being a difficult boss. But this book is about more than Steinhardt's investment victories, which are myriad. It is also an autobiography in which Steinhardt details his rise, his contradictory relationship with his father – a gambler, who later runs afoul of the law – his devotion to his religion and his political activities.

Steinhardt, among an army of credulous people, befriends Bill Clinton as the up and coming governor of Arkansas. In fact, his financial support helps Clinton become a national figure and ultimately helps him achieve the presidency. Steinhardt also tells us about his transition from a somewhat Conservative Republican (he voted for Goldwater in 1964) to a middle of the road Democrat.

He becomes a trusted adviser to the Democratic Leadership Council (DLC), which helped Clinton in 1992 by making the case the Democrats had moved to the center of the political spectrum and should no longer be seen as radical elites who were out of touch with the average American.

Once elected, Steinhardt and others at the DLC complain that Clinton ignored them. They believe that he ignored the moderate principles he claimed to avow when running. Clinton, Steinhardt complains, seemed to want to be everything to everyone.

"Indeed, I came to believe that Clinton did not have a consistent philosophic center." (page 215). Translation: Our former president told lies. No, kidding! Clinton is a career pol. What did Steinhardt expect? Honesty? Consistency? A man of rectitude who abhorred lying in any form?

My point is that Steinhardt, a master of the universe in hedge funds, wouldn't have been taken in by money management mountebanks, yet he was easy pickings for the likes of Bill Clinton and other such politicos.

We also learn, in the back part of the book, about Steinhardt's unsuccessful forays into financing motion pictures, which turn out to be expensive, silly episodes.

In these last few hundred pages of this interesting work, the book takes on a different tone. All of a sudden the brilliant Steinhardt is no longer so brilliant. His judgments are often flawed, at times, nave. Even though a reader respects Steinhardt's manager triumphs, one concludes that he should stick to his knitting. One must think that, even great hedge fund managers, can be klutzes when they're not running money.

It is as though one discovered that the extraordinary Benjamin Graham – extraordinary because the great value investor was also a linguist, scholar and Renaissance Man – was actually a Babbitt, who could be easily taken in by third-rate pols on the make. (Now I may be credulous, but I can't imagine Graham taken in by Bill Clinton.)

When Michael Steinhardt talks about hedge funds, investing or traders, then I am respectfully listening. But so many otherwise successful people in our world stumble when they insist on moving away from their metier, when implicitly they believe that their genius is transferable from one field to another as easily as one transfers from one train to another.

Beethoven was one of the greatest composers. He made the human race incalculably richer. His greatness came, in part, from his ability to put simple as well as profound thoughts into music both beautiful and heroic. (One should remember that the great Beethoven was taken in for a time by the promises of Napoleon. The Eroica was originally to have been dedicated to him, but he was later enraged by Napoleon's imperial ways and tore up the dedication.)

Still Beethoven, with all his musical genius, was not a great painter. Babe Ruth can play or pitch for my team anytime. I just don't want him to manage it unless my goal is a team that resembles something out of the movie "Animal House."

One should not be blinded by Steinhardt's remarkable Ruthian record running money. When Steinhardt is offering his opinions about politics or movies, then he is no better than an average, television-watching boob. Indeed, if he is giving me his views about former presidents, he may be worse.

If the partners at Einhorn & Co., a small Big Board specialist, had any doubts about selling out in the summer of 1999 to the big Dutch trading house Van der Moolen Holding, they soon vanished.

In January 2001, Time Warner, one of Einhorn's top money-spinners, was delisted following its merger with America Online. The loss would have been devastating for Einhorn as Time Warner represented about a quarter of its revenues. But as part of Van der Moolen Specialists USA, the fifth largest specialist at the New York Stock Exchange, the traders at Einhorn survived to trade another day.

Einhorn is one of seven small and medium-sized Big Board specialists to sell out to Van der Moolen Holding in the past two-and-a-half years. One of the two largest, Lawrence, O'Donnell, Marcus became the platform upon which Van der Moolen Specialists was built in 1999.

It contributed four members to the firm's six-man management committee, including chief executive Jimmy Cleaver. The build-up followed an earlier aborted attempt to create a presence on Wall Street through a tie-up with the specialist LaBranche. The other large specialist, Fagenson, Frankel & Streicher, came aboard in 2000. Robert Fagenson, its CEO and a former New York Stock Exchange vice chairman, also joined the management committee.

Crowded World

Van der Moolen Specialists now trades 395 stocks, or 15 percent of the total number of NYSE stocks, with nearly 70 specialists and 230 clerks all piled on top of each other in the crowded world that is the floor of the New York Stock Exchange.

The firm is the only partnership among the top five specialists. Van der Moolen Holding has a 75 percent stake while 53 U.S. partners own the balance. That minority stake serves as an economic incentive, of course, but also engenders a family business-like culture, executives say.

"Everyone is very close here," said Joe Bongiorno, a managing partner and co-head of floor operations. "We're all friends, not just partners."

As Van der Moolen Specialists, the traders hope their collective might and larger capital base will allow them to prosper on an increasingly competitive Big Board floor.

Only eight specialists remain at the Exchange, down from 54 in 1986. The top five control over 90 percent of the volume.

Van der Moolen's rapid build-up has made it a contender for the major leagues, but it is still the kid brother in a room full of big boys. The firm trades 11 percent of the volume, but LaBranche trades 27 percent; Spear, Leeds & Kellogg trades 24 percent; Fleet Meehan trades 18 percent; and Wagner Stott Bear trades 16 percent.

Size matters. A large equity base helps a specialist firm stomach the increasingly huge positions it must take. In addition, that capital and a firm's market share are major selling points when bidding for new listings.

Those new listings, or allocations, are the lifeblood of any specialist. Unlike the Nasdaq market maker, a specialist can only trade those stocks he is allocated. And, the bigger and more actively traded they are, the greater the profits. In the first six months of 2001, about 30 percent of Van der Moolen Specialists' revenues came from its ten most active stocks.

Jefferies analyst Charlotte Chamberlain is not sanguine about the firm's prospects. In a report, she notes that a nine percent share is not enough to attract "high-trading-volume prime listings."

Chamberlain says that Van der Moolen Specialists "faces not only declining market share, but potentially dwindling profitability." It will be stuck with thinly-traded stocks, for which it will have to provide loss-making liquidity, she adds.

Before March 1997, a company seeking to list its shares on the New York had its specialist chosen for it by the Exchange. Since then, the listee has had the option to choose its own specialist. Most apparently do so. And of the 21 new listings in last year's first quarter, none went to Van der Moolen.

Another Edge

Three of the top five specialists have another edge: They are owned by large banks with underwriting capabilities. The theory is that the banks will steer their IPO clients to their own specialist units for aftermarket support. Spear, Leeds is owned by Goldman Sachs; Fleet Meehan by Fleet Boston; and Wagner Stott Bear by Bear Stearns.

Chamberlain has a buy recommendation out on Van der Moolen Holding's ADRs, but largely because she views it as an attractive takeover target. It is simply not big enough.

"Without a good shot at the best listings, Van der Moolen Holding's earnings growth is limited to overall market growth," she said. "The franchise value of the NYSE specialist operations will gradually recede over time."

The remaining specialists are apparently too small to give Van der Moolen Specialists the heft it needs, assuming it could acquire them.

Big Boy's Club

Van der Moolen lost its chance to join the big boys' club when a deal with Wagner Stott Mercator fell through. A combined Wagner Stott/Van der Moolen would have accounted for about 20 percent of NYSE volume last year, putting it fourth in the rankings. Instead, the plum went to Bear Stearns.

But while Van der Moolen may be at a size disadvantage, its executives argue that the very nature of the firm bodes well for the future. Because much of the growth of the New York Stock Exchange will come from foreign listings, a transatlantic trading house has an edge.

Of the $16.2 trillion in market capitalization represented by the Big Board's 2,646 companies, $5.5 trillion, or one-third, is attributable to foreign listees. That is significant when one considers the total number of stocks on the Big Board has declined from 2,769 since 1996.

Van der Moolen says it can ensure a smoother trading experience for a European company's shares both at home and on the Big Board, if it opts to list there.

The key is information flow, say Van der Moolen executives. "If something is happening in a stock," said Mike Stern, managing partner and co-head of floor operations, "we'll get a call from Europe."

This communication link was the basis for Van der Moolen's first foray into the U.S. market in the mid-1990s. The Dutch dealer bought a 24.9 percent stake in LaBranche in 1995. The hope was to establish a relationship in which the two firms passed the book' when one market closed and another opened. Van der Moolen would trade the European shares in Europe; LaBranche would trade the ADRs in New York.

But when Michael LaBranche became president in 1996 the relationship foundered. His preference was to chart an independent course funded by a public offering. In 1999, Van der Moolen sold its interest back to LaBranche for $90 million.

The Dutch firm's urge to merge with a New York specialist happened because of problems on its home turf. As the largest specialist on the Amsterdam Stock Exchange, trading between 40 percent and 45 percent of the volume, Van der Moolen hit a brick wall in 1994. The bourse decided it was too big and would not give it any more allocations. Its growth stunted, Van der Moolen went in search of greener pastures.

According to Casper Rondeltap, the only Dutch member of the six-man board, the firm was drawn to the New York Stock Exchange for its specialist system and tremendous volume.

Euronext

Hastening the firm's need to spread its wings was last year's elimination of the specialist function by Euronext, the electronic stock exchange superceding the Paris, Amsterdam and Brussels exchanges. Euronext adopted the Paris bourse's trading system which works with "market makers" rather than specialists. Market makers do not have exclusive franchises, but, rather, compete with each other.

Van der Moolen has, in effect, bet much of its future on the New York Stock Exchange. And the transformation has been nothing short of dramatic. In 2000, a year in which four of the seven specialists were in the Van der Moolen fold, the NYSE specialist operation grossed $250 million, or 64 percent of total revenues of Van der Moolen Holding.

In 2001, with all seven specialists in tow, it is expected to make about $220 million. Revenues are lower – the loss of Time Warner hurt – but the percentage of the total gross hit 72 percent. It's the mirror image of 1996, when European operations accounted for about 70 percent of the pie.

Profits at Van der Moolen Specialists, like those of most specialists, come largely from trading on a principal basis. Typically, according to the firm's executives, it's a case of doing well by doing good. Van der Moolen supplies brokers with liquidity and later unwinds those positions at a profit.

In fulfilling its obligation to make "fair and orderly" markets, the specialist profited on 93 percent of all trading days during the first six months of 2001.

Most of Van der Moolen's principal trading efforts apparently involve either "staircasing" a stock so its upward or downward trajectory goes smoothly, or offsetting intra-day imbalances between buy and sell orders.

When staircasing a stock, the specialist will use the firm's capital to ensure that the customer does not trade at a price too far removed from the last sale. For example, if a seller is faced with a last sale of $29.15, but a best bid of only $29.05, Van der Moolen may step in and buy the stock at $29.10. Staircasing is done mostly in the less liquid names since there is enough natural' trading interest in the big stocks.

A specialist is permitted to trade purely opportunistically if all customer orders are satisfied. Van der Moolen executives say, however, it is impossible to ascertain how much of its profit results from obligation and how much from opportunity.

"They go hand in hand," said Mike Hayward, managing partner and co-head of floor operations. "It's impossible to break those numbers out."

Last year, 84 percent of its floor revenues came from principal trades. The remaining 16 percent came from the commissions received when acting as agent for customer limit orders. Whether a broker in the crowd hands the specialist a slip of paper or the order comes in electronically, Van der Moolen will watch the order until a match presents itself. For doing this, it makes an average of 15 cents per 100 shares.

This is not a growth area. Decimalization and new rules from the New York Stock Exchange have reduced the opportunities for specialists to profit from executing limit orders.

In 2000, the Big Board increased from two minutes to five minutes the amount of time an order could sit on the specialist's book before becoming billable. The rule change decreased the number of billable orders.

Penny Increments

Decimalization exacerbated the situation. Contrary to some reports, trading in penny increments has not caused the number of limit orders arriving at the floor to decline, say Van der Moolen execs. Those arriving, though, are more likely to be marketable because all the additional price points provide more trading opportunities. Marketable limit orders are, of course, unbillable.

The reduction in commission revenues hurts, but Van der Moolen says it's first and foremost a trading operation. "We don't rely on our commissions," said Bongiorno. "If we don't make it in trading, we're not making it."