Mark Borrelli is an ex-Securities and Exchange Commission attorney now working in the private sector.

His soon-to-be-published paper, "Market-Making in the Electronic Age," argues that ECNs are being short-changed under the current regulatory structure. He urges the SEC to make it easier for ECNs to participate in the so-called National Market System (NMS).

The NMS is the SEC's concept of a single, unified stock market created by the electronic linkage of the country's market centers.

It is considered to comprise four subsystems. The Consolidated Tape Association (CTA) and the Consolidated Quotation System (CQS) broadcast quotes and transactions emanating from the nation's stock exchanges and Nasdaq's InterMarket. The Intermarket Trading System (ITS) broadcasts quotes and permits trading between members of self-regulatory organizations (SROs) in listed securities. Finally, the Nasdaq Quotation System broadcasts market maker quotes and transactions.

Borrelli, 37, spent eight years in the SEC's Chicago office on the enforcement side. At the law offices of Shefsky & Froelich in Chicago since 1999, he has advised broker dealers and investment advisors on compliance issues. His clients, however, do not include ECNs

Traders: What is the problem for ECNs?

Borrelli: Regulation ATS effectively mandated ECN participation in the NMS, but put up barriers to their doing so.

Traders: How so?

Borrelli: To get access to the NMS, ECNs must either become exchanges or work through competitors, like Nasdaq or the exchanges.

Traders: A few are trying to become exchanges. What's the problem there?

Borrelli: It's a slow process. Island has been trying to become an exchange since June of 1999. One of the major barriers is the requirement that an exchange must be able to fulfill its self-regulatory function. They can contract out that function to one of the SROs, but that is not really viable given the intense competition between the ECNs, Nasdaq and the exchanges. And no one is even sure if the existing SRO system will remain intact.

Traders: And if they do become exchanges?

Borrelli: If they do become exchanges then they must join the associations that govern the NMS. These are strange alliances made up of competitors who must get together and run the systems.

Traders: You are referring to the committees that administer the CTA plan, the CQ plan, the ITS plan, and the Nasdaq UTP plan?

Borrelli: That's right. It's a huge disadvantage for the ECNs. In these groups, you need unanimity to make any changes. So, it's impossible to get anything done.

Traders: The alternative to becoming an SRO is to work through competitors?

Borrelli: Yes. Currently, ECNs disseminate their quotes and trade through the facilities of Nasdaq. Although technically Nasdaq is not an exchange, I view them as like an exchange and, therefore, a competitor. Nasdaq, in fact, wants to become an exchange. ECNs would prefer to run their own market and not have to go through Nasdaq. In a lot of ways, they are treated as if they were market makers. But, the ECNs really operate their own distinct markets.

Traders: The ECN, Bloomberg Tradebook, recently began using the Philadelphia Stock Exchange to post its listed quotes in the NMS. Is that the same thing?

Borrelli: Yes. Tradebook is gaining access to the CQS and the CTA through Philadelphia, which is a participant in the plans.

Traders: What is your solution?

Borrelli: The SEC needs to completely overhaul the facilities of the National Market System. The SEC should provide for the creation of one or more for-profit organizations to take over their operations. ECNs need to be able to directly disseminate their quotes into a central system, rather than being dependent on competitors.

Traders: How would that help?

Borrelli: If everyone had equal access to the NMS, speed and quality of execution would play a bigger role. If one party had superior technology they would gain more of an advantage than they have now. Another marketplace might gain an advantage because it works better in volatile markets. Also, the current system, which requires the exchanges and Nasdaq to jointly operate the NMS facilities, simply doesn't work.

Traders: Right now the quoting and trading facilities for listed stocks are separate from those for Nasdaq stocks. Your plan combines both into one organization?

Borrelli: Yes. Nasdaq would be treated as one of the exchanges putting quotes and trades into the system. This makes a lot of sense, especially now that so many stocks are being traded away from the markets on which they are listed.

Traders: So, in effect, your plan would put ECNs on equal footing with Nasdaq and the listed exchanges?

Borrelli: Yes. People would compete on the basis of technology to win market share. ECNs would not be constrained by using the facilities of one of the other markets.

Traders: This organization would operate an order routing service along the lines of the ITS?

Borrelli: I think it should. It could fulfill the functions of the ITS, but more efficiently.

Traders: Thanks, Mark.

Charles Darwin would have a field day with the modern retail brokerage industry. After all, when you look at the industry's evolution over the past decade, it's a case study in natural selection. If it's true that only the most adaptive species will survive, then the role of the traditional broker in online trading is going the way of the dinosaur.

The Internet was the catalyst in a revolution in retail brokerage. Instant access to information and speed of communication combined to put more decision-making power into the hands of the retail consumer.

At the same time, Charles Schwab, a household name in financial services, began marketing low-cost brokerage services to the retail investor.

Suddenly, having a broker was no longer a privilege restricted to the "elite" — it was now a service within reach of virtually any consumer with funds to invest.

In 1996, these trends in the Internet and brokerage business converged. That's when Schwab introduced the first online brokerage firm. Shortly thereafter, E*Trade, Ameritrade and others followed suit, introducing new levels of choice and savings.

Today, there are some 150 online brokerage firms. Forrester Research predicts that about 21 million households will be trading online by the year 2005. The question is, has the online brokerage industry provided value for the retail investor?

It's true that online brokers have introduced dramatic cost savings for self-directed retail investors. They've also given the retail community greater access to proprietary investment information. But, as they say, the more things change, the more they stay the same.

The reality is, despite claims to the contrary, it's still largely "business as usual" in the brokerage business. In most cases, today's online broker is nothing more than the old brokerage model with an electronic interface.

Brokers still charge consumers a commission for their trades. They still funnel these orders to outside market makers and pocket the payment for order flow. Everybody profits — except the retail investor who makes it all possible.

Which brings me back to Charles Darwin. It's time for the next evolution in online trading.

Currently, online brokers use retail order flow to support two revenue streams: commission fees and payment for order flow. They act as classic "middlemen," standing in between the retail investors (who generate order flow) and market liquidity (provided by the market makers). The problem is, the role of the middleman has become irrelevant to an increasingly savvy retail investor.

The next logical step in the evolution of online brokerage is to bring the retail investor and the market maker together, cutting out the role of the traditional broker. Self-directed investors, already accustomed to doing their own research and analysis, can go straight to the markets they trade.

Liquidity for market making operations will come from retail order flow, not through relationships with outside brokers.

Most important, the retail investor will share in the cost efficiencies of this business model through no or low commissions and rebates (that is, rewards) for the payment for order flow they provide.

"Free" and "rebate" aren't new to online brokerage. Ameritrade's Freetrade, for example, offers free trading and Datek provides a rebate on the payment for order flow it receives through third-party market makers. The difference between these offerings and this next evolution is the underlying business model.

Most brokerage firms don't have significant market making operations and, therefore, are dependent on the fees generated through today's operational dinosaur — the traditional broker. Those firms that do make markets in certain products certainly don't share the benefits with the retail investor.

This will have to change. BrokerageAmerica, for example, now connects retail investors directly with its market making operations. But it won't be easy for the established brokerage firms to adopt this new model.

In fact, it will be a very painful process. But the reality is that technology and a changing consumer will continue to transform the business.

The only way to avoid extinction is to anticipate the next evolution in online trading.

Drew Sycoff is chief executive officer of BrokerageAmerica, a unit of Andrew Garrett Inc., a New York market maker in 1,000 Nasdaq stocks.

For nearly 30 years Kevin Connellan was on the sellside. Last year he made the biggest trade of his life. The veteran sellside trader switched over to the buyside.

Connellan joined Northern Trust Investments, the asset management arm of Chicago-based Northern Trust Corp. in August, as director of equity trading. He manages a desk that comprises four traders.

Northern Trust has some $330 billion in assets and equally trades both listed and Nasdaq stocks for its parent firm's trust accounts, as well as for its group of growth mutual funds.

Born and raised in Dublin, Ireland, Connellan originally had aspirations of becoming a rock 'n' roll star. Soon after completing his education he packed his bags in the early 1960s and headed to the U.S. with an Irish rock group, K.C. and the Spenders, hoping to make the New York club scene. He played the drums. While he followed his musical dream, he also landed a job as a booth clerk for a specialist firm at the New York Stock Exchange.

"I always had an interest in the stock market," Connellan said. "Growing up in Ireland, I was familiar with the London Stock Exchange."

After a few years working at the Big Board during the day and at night playing renditions of top 20 hit songs in smoke-filled nightclubs, Connellan decided to trade in his drum sticks for order slips. He joined Blythe Eastman Dillon & Co. as a sales trader. A few years later, Connellan moved to Chicago, launched a trading desk for Drexel Burnham Lambert and managed the firm's Midwest trading operations. He joined Schroder & Co. in 1990 and, once again, he set up a trading desk.

For Connellan, a veteran sellside trader, the buyside today offers many opportunities. "A lot of buyside firms are recognizing the value of upgrading their desks and having more efficient traders," he said.

One of the main attractions for Connellan at Northern Trust was the firm's tremendous growth. "I felt that I would be able to contribute my talents not only in the trading arena, but also in technical things like setting up order management systems," he said. "One of my objectives here [at Northern Trust] is to upgrade our order management."

Connellan contended that, increasingly, more sellside traders are jumping the fence to the buyside. "I think the talents between the two are starting to merge," he said. "It is absolutely essential that buyside traders have good trading skills. You can't bring someone on board anymore and have them work just as an order taker."

The former sellside trader also foresees the compensation structure for the buyside adapting to the changing marketplace. Connellan believes the days of compensating many buyside traders with a fixed salary will give way to a pay scale that is based more on performance. "If the trading desk can help performance, then the traders will be compensated accordingly," he said.

The recent switch-over to decimals has disturbed some on the buyside. One of the big complaints among buyside traders is that they are 'pennied' by specialists at the NYSE.

Due to decimalization, Connellan suggested, many more buyside firms will be motivated to become members of Liquidnet, which now has about 45 members. The newest alternative trading system, Liquidnet, he contended, has the wherewithal to become a threat to the Big Board.

"Unlike OptiMark," Connellan said, "Liquidnet is much more user-friendly. It has the capability to deliver – if it gets the critical mass."

To Connellan, market fragmention is something that a lot of pros talk about remedying, but nothing substantial is ever accomplished. He has little confidence in SuperMontage bringing about fundamental change. "You will see a depth of three different prices," he said, "but with decimalization the prices will only be in increments of a few pennies."

Like many traders on both the buyside and the sellside, Connellan enjoys playing a few rounds of golf. He also takes delight in supporting his wife Mary Ellen's efforts for charities in the Chicago area. She is executive director of the University of Chicago Cancer Research Foundation. She also serves on the board of many other charitable organizations. "We go to a lot of fundraising events. Every dinner is a $250 a plate. You can't go to McDonalds with her," he quipped.