The Chicago Board Options Exchange, under threat from an electronic options exchange planned by several leading Wall Street brokerages, is planning to hit back with its own system.

The CBOE has almost finished the system, which will rival the one planned by the International Securities Exchange (ISE), according to people familiar with the plan.

The ISE is set to be launched by Menlo Park, Calif.-based E*Trade, Jersey City-based dealers Knight Securities and Herzog Heine Geduld, as well as other participants.

The CBOE is the largest U.S. options exchange with the American Stock Exchange ranking second.

At press time, the ISE was waiting for approval by the Securities and Exchange Commission. David Gray, a spokesman for the CBOE, said the exchange had no comment.

Many trading pros say the introduction of heavily computerized equity trading is motivating the CBOE's decision However, the prospect of losing significant order flow to the ISE is a much bigger threat, some pros say.

"Clearly, the CBOE is reacting to the ISE," said Bikrim Singh, an electronic commerce analyst at Lehman Brothers.

Another possible threat is the American Stock Exchange, an affiliate of Nasdaq. The National Association of Securities Dealers has spoken of electronically linking its Nasdaq and AMEX options businesses.

Multiple Listings

The U.S. options exchanges are also feeling the heat as options on individual companies trade on several exchanges for the first time.

In an increasingly competitive environment, Singh said the CBOE could be eyeing the retail market.

"If the individual investor is educated about how to use options as an investment strategy," he said, "there is a strong opportunity for electronic mediums to attract significant order flow from the retail sector."

Anew group of publicly-traded Internet-based companies is looking at the debt markets for operating capital.

After this year's high-profile convertible bond offerings from Amazon.com, DoubleClick and Sportsline USA, several other similar dot.com companies are waiting in the wings for the same capital-raising opportunities.

The reason: Convertible bond offerings seem to offer better potential returns than the returns provided by secondary equity offerings, which have had depressed stock prices.

A convertible bond is essentially a hybrid security, incorporating elements of equity and debt. The bond is convertible into equity, usually after three years of life.

Net Convert

One recent Net-connected convertible deal involved a 144A private placement from VerticalNet valued at $115 million. VerticalNet had seen its stock price fall 50 percent since April. Clearly, the company could not afford to irritate shareholders by returning to the equity market for more capital.

"The preferred mechanism for Internet companies is to sell at a maximizing price point," said Frank J. Drazka, a managing director in the technology investment banking group at PaineWebber. "Convertible debt offerings provide an attractive way to minimize equity dilution while still raising the same amount of money."

Despite the fickleness of the convertible bond market, investment bankers suggest that convertible bonds will become increasingly popular. They say Internet companies will use them to balance their capital structure as they build their war chests.

"We're in active discussions with a lot of [Internet]companies about doing convertible debt offerings," Drazka said.

Rather than diluting existing shareholders value by selling equity at a depressed stock price, companies seek higher ownership participation via a convertible offering.

Typically that participation amounts to a 15 percent to 20 percent premium on the current stock price. For example, VerticalNet's five-year convertible note issue, which was led by Lehman Brothers, carried an initial conversion premium of 18.08 percent. Such a structure had obvious appeal to VerticalNet, a company whose stock recently slid to 35 1/6 from 74 1/2 in April. (Moreover, insiders were free to sell shares by the recent expiration of lock-up agreements.)

"It can be an attractive alternative to a secondary stock offering," said Tomas Isakowitz, an analyst at Janney Montgomery Scott. Still, Isakowitz noted that there can be some negative implications, particularly if insiders are selling stock, as is usually the case with Internet companies. Another alluring feature of a convertible offering is the ability of the deal to draw a new class of institution into a company's investor base.

Managers of convertible bond funds may provide the spark to ignite a new rash of Internet-led convertible bond deals. Until recently, these managers were consigned to watching their equity counterparts feast on hot Internet offerings.

"There are a lot of bond funds that want to play," said Dan MacKeigan, Internet analyst at Friedman, Billings, Ramsey & Co. Most of the Internet companies participating have been infrastructure and telecommunications-based outfits. But that seems to be changing as other types of Net companies join the bandwagon.

Amazon.com was the first Internet company to expose this pent-up demand. Originally in the market for $500 million, the Internet retailer was able to sock away $1.25 billion from its 4.75 percent, 144A convertible placement in January.

Second Tier

While the convertible bond market has provided an appealing alternative for some Internet industry leaders, it may be more difficult for second-tier companies to pursue similar financing strategies. In fact, even the much-hyped Priceline.com fell victim to the convertible debt market's unpredictability in its August attempt to float a $250 million offering.

Although the "name-your-own-price" retailer was able to place a secondary stock offering of 5.5 million shares, the convertible market balked at the company's $33.8 million operating loss in the first half of the year.

The convertible strategy even holds risks for the likes of Amazon.com. "The fact that Amazon's offering is convertible has no bearing on its debt rating," said Standard & Poor's analyst Jerry Hirschberg. If management fails to execute its business plan and achieve profitability, the debt never converts and the company must continue to fund coupon payments. On Amazon's $1.25 billion note, that bill comes to around $60 million annually.

Stephen Lacey is managing editor of The IPO Reporter, a sister publication of Traders Magazine.

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.

Decimalization is only seven months away from replacing the fractional system used in the U.S. for quoting stocks. Retail investors may be pleased but some institutional traders are downright apprehensive.

"The market moves fast enough as it is," said Gary Kaplowitz, head of Nasdaq trading at Fahnestock & Co. in New York.

"Decimalization is going to increase the frequency of price fluctuations. Quotes will be all over the place, making it harder to get in and out of positions," he added.

Kaplowitz is worried about a Securities Industry Association-led plan to move the industry into a decimal-based trading environment – a plan that would see the current minimum increment tumbling lower.

Today's minimum tick of one-sixteenth, or 6.25 cents, could drop to a penny on many of the most heavily traded stocks. That could encourage traders to quote more small orders at the inside price. If it only costs a penny a share to trade, more investors will likely participate in the market. But that penny a share scenario would make it more difficult for Kaplowitz to execute large orders. He would have to work far more 100-share orders and at a faster rate than he does today.

The Outcome

Rapid-fire trading is possibly just one far-reaching result of how decimalization will affect both buyside and sellside traders. The sellside will see thinner spreads on large-cap Nasdaq stocks, such as Microsoft, Cisco and Dell Computer, according to the experts. The buyside will see reduced depth on listed markets, they add. The individual investor, however, is expected to be the big winner of stock prices in decimals.

But then that's the point. Decimalization was forced on the markets by Congress in 1997 partly to save retail investors billions of dollars per year. That was supposed to happen by the aforementioned reduction in minimum tick sizes by market centers like the New York Stock Exchange and Nasdaq.

Smaller trading increments would intensify competition among all sorts of limit order traders. Market makers, day-traders, hedge funds, and arbitrageurs would all try to better each other's quotes, leading to price improvement for the customer.

The "Common Cents Stock Pricing Act," or HR 1053, was introduced in the House by representatives Michael Oxley (R-Ohio) and Edward Markey (D-Mass) in March 1997. "A modern decimal system is better for small investors," Oxley said. "People are being eighth-ed and sixteenth-ed right out of their stock profits."

The bill required decimalization as quickly as the SEC thought it could handle it. Three months after the legislation was introduced, the NYSE voted to trade in decimals and cut the minimum trading increment from one-eighth to one-sixteenth. Oxley and Markey then pulled their bill. Nasdaq soon announced its own move to decimals. The SIA recently sent its plan to the Securities and Exchange Commission, calling for decimal trading to begin on July 3, 2000. Stocks would trade in nickel increments for three months, then in whatever increments decided upon by individual market centers. Most expect the tick to drop to a penny for the most active issues.

"I think we will see penny ticks for a couple of years before the markets realize their mistake," said Dan Weaver, a professor at Baruch College's Zicklin School of Business. "Eventually the market centers will get together and set a higher minimum." Weaver, a longtime scholar on the issue, believes five cents is low enough.

But Junius Peake, professor of finance at the University of Northern Colorado and a proponent of decimalization, says market forces should determine the minimum tick. "The New York Stock Exchange, among others, would like to maintain a large enough tick size to benefit from the inefficiencies of the market," Peake said. "But that unnecessarily increases the cost of trading. Any time you increase the cost you have less trading and fewer people involved. I mean it's Econ 101. If you reduce the price of something, people will buy more of it. Look what happened when they deregulated commissions in 1975."

Serious Concern

Most traders and market watchers say the initial drop in the tick size from one-sixteenth to a nickel will have little effect on trading conditions. It is the expected drop to one cent that has them worried.

"Anything less than five cents will be detrimental to the market as we know it," said Buzzy Geduld, president of wholesaler Herzog Heine Geduld. "It's the death knell for the principal business." Principal trading involves risking capital by taking positions in stocks.

Geduld and others are predicting that, once tick sizes drop to a penny, spreads will do the same. After the introduction of teeny' ticks and the increased competition from limit order traders, newly protected by the SEC's order handling rules, market makers' spreads fell about 30 percent in 1997. The same thing happened on the Toronto Stock Exchange when it converted to decimals three years ago. The minimum trading increment was cut from one-eighth, or 12.5 cents, to five cents for stocks trading over five dollars (Canadian). Spreads narrowed and trade sizes dropped as well, according to a study by Indiana University's Jeffrey Bacidore.

What's bad for wholesalers like Herzog, however, may not be bad for wirehouses like Merrill Lynch and Goldman Sachs. Wirehouses charge clients a credit,' or a form of commission, for executing Nasdaq trades. That payment is unlikely to drop much with decimalization, market insiders say. Today, credits are, at most, one-sixteenth per share, equal to the spreads on many socks.

If those spreads narrow, wholesalers will see profits pinched, but wirehouses are not expected to reduce the credits. All told, eight wholesalers and eight wirehouses control 70 percent of all Nasdaq trading, according to AutEx BlockData.

The Buyside

On the buyside, spreads are of less concern than liquidity. "Trading in size is more important for us," said Brian Pears, head of equity trading at Wells Capital Management. "We generally execute at average prices anyway."

The depth of the market, a key component of liquidity as measured by the number of shares available to trade, is not expected to change on Nasdaq. Market makers' best priced advertised quotes are accompanied by the number of shares they have publicly available. At the moment, that amounts to a bare minimum. The true depth of the market is not revealed. Quoted sizes aren't expected to drop further with decimalization.

Depth in the listed market is a different matter. "With penny increments it will be much easier for traders to jump in front of a large order," Weaver said. "Quoted depth will suffer because institutions will hold their orders back."

In other words, an institution with a large limit order will not automatically send it down to the floor because other traders would only need to better it by one cent to "steal" the trade. The institution would then pay more or receive less when it finally does execute. By holding the order back, the institution doesn't tip its hand, but it also reduces liquidity on the exchange.

Not all market participants are convinced that aggressive penny' traders will wreak havoc and engage in so-called penny jumping.' "I have a hard time believing that something's going to be $72.38 bid and $72.39 offer in size," said Tom Hearden, a trader at Menomonee Falls, Wisc.-based mutual fund giant Strong Capital Management.

"There will always be a little stuff floating around," he added, "but I just can't see the market being that efficient and people that willing to disclose that they have size. Penny markets will take a while to happen, if ever."

The minimum trading increment is expected to tumble to a penny when the U.S. stock markets switch to decimal pricing next year. In stock trading, dollars and cents will replace the pricing of stocks in minimum fractions of one sixteenth of a dollar. For example, $20 1/4 would be expressed as $20.25.

At the start, decimal pricing is expected to be in minimum increments of a nickel. Later, the minimum increment is likely to be a penny on the most heavily traded stocks, trading pros say. Penny ticks will not dramatically increase the number of shares traded on Nasdaq and the listed markets, according to a study by SRI Consulting. But quoting and the number of trades will skyrocket, says the securities industry advisor. As a result, average trade sizes will drop by about 40 percent on both markets.

Quoting will increase because the number of price points within a dollar will increase from 16 today to 100 a year from now. Traders will have a wider range of quoting levels at which to place their limit orders. That goes for market makers' best bids and offers as well as day traders' orders on ECNs and the NYSE's SuperDOT system.

The number of shares associated with each quote is expected to decline as traders implement new risk strategies. Under today's teeny regime, limit order quotes bunch at only 16 levels. That means there is considerable size associated with each level. Penny ticks will allow traders to spread all that size out over potentially 100 levels.

So, the number of trades will increase and their accompanying sizes will drop as market orders execute at many more price points.

Aldo Parcesepe Sr. Managing Director OTC Trading Bear Stearns & Co.

Wider spreads? That's a possibility. I think that the forces of supply and demand will dictate whether [the minimum trading increment] will be rounded up or down. [Regulators] are making one assumption that it's going to be rounded down. It might very well be rounded down, but the costs that drive the marketplace are going to drive the rounding, not the fact that they pass a rule saying that [the minimum increment] must be a decimal. If people can't make money at narrower spreads then the spreads will widen.

I think the regulators would like for us to do business at a penny a share. The reality may be something different. As you decrease the commission base you get to a point where you can no longer make the overhead. At this point people will start walking away because they cannot support their business.

Ideally it might be nice to do business at a penny a share, but what kind of service would you get at a penny a share? You'd be getting service worth a penny a share.

Agency business? Anyone who tells you that [market makers] should be doing agency business is putting the cart before the horse. Institutions are accustomed to doing business on a net [spread] basis. Presently, Nasdaq does not provide a central location. Why should institutions pay agency commissions when they are not assured of price and time priority?

Dan Weaver Professor of Finance Zicklin School of Business Baruch College

With nickel increments we will see very little change. Maybe a slight narrowing of spreads. Marginally more people will trade. A slight increases in volume. The penny is a completely different story.

If we go to one cent we will see a reduction in quoted depth on listed markets. People will be reluctant to reveal their limit orders because other traders will step in front of them. They won't stop trading, they just won't reveal their orders to the public. They will be kept on proprietary systems and then sent in. We could also see an increase in volatility. Orders won't be there to absorb the price shocks.

This wouldn't be a problem if the NYSE allowed hidden' limit orders. But the SEC is against that. They wrongly believe that the order belongs to the market. All information is good. They're dead wrong.

I believe the NYSE and the American Stock Exchange prefer to see nickel increments. But the current environment is pro-competition. I think we will see penny ticks for a couple of years before the market centers come together and set minimum increments.

Payment for order flow? Decimalization will not eliminate payment for order flow. Market makers will partition order flow. They will keep the uninformed orders and send away the informed. Payments will probably be reduced. They were after the order handling rules came in.

Lawrence Scinto Senior Consultant SRI Consulting

If you assume that the MPV (minimum price variation) will drop to one cent it will create more opportunities for active traders like hedge funds, day-traders, and arbitrageurs. We expect quote traffic on Nasdaq in 2001 to be 230 percent greater than our baseline [non-decimalization] forecast for that year. Trades are about 80 percent higher.

With the rise of ECNs and the implementation of the order handling rules, anyone can put in a limit order and change the inside price. Penny increments will make it even easier. Traders will use computers to penny' people.

The number of shares per trade will continue to decline. This is a trend that has been under way for some time… primarily as a result of more retail orders in the market. Decimalization will exacerbate the trend as institutions break up their orders more to deal with liquidity spread out along more price points. Also day-traders may try to capitalize on penny opportunities.

Spreads will narrow, but not uniformly across the board. Mostly the more active, the more liquid stocks…Market makers will drop some of the less active stocks from their trading roster. Wholesalers will take up the slack.

Brain Pears Head Trader Wells Capital Management

This is another in a long series of margin-crunching moves. It will do some good for the investor, but is there another side of the coin? It is incumbent on you as a money manager to make sure that brokers are doing the same kind of job they did when they were making money. But the move from one-eighth to one-sixteenth did not result in a drop off in service. At a nickel we don't foresee any change in service.

Commissions on Nasdaq have been talked about a lot. We are prepared for it and have written it into our client documents. I don't see how Nasdaq can remain a true dealer business. ECNs have always been pushing. They've brought about tighter spreads. This is the final step.

Anonymous Trader at wirehouse

You'll see a lot more flickering markets' representing people trying to chase markets. It won't be a lot different than today, but a lot more intense. As decimalization comes you'll see a lot more cancel and replacements… people will cancel at 10 bid and make it [a 10 and an ] eighth bid. So, in fact, you'll see a lot more message traffic. It'll probably become a lot faster.

But it's all automated. It won't require more inputting by the trader on the desk. I don't think you'll have to add more traders. The functionality of the workstation will have to change.

We probably won't reduce the number of stocks we trade. We did somewhat after the order handling rules came in, but we are pretty comfortable where we are now. I think we've adapted to that already.

Tom Hearden Trader Strong Capital Management

Is decimalization something that's good? Yes. It's better for investor and it's easier [to use].

And for traders? I'm sure the statistics will show that spreads have narrowed based on the fact that the best bid and offer have narrowed. But the real dollar implications of where size traded and whether [narrower spreads] mattered is an open question.

If I'm paying up an eighth now to buy 50 [000 shares], when we convert to decimals will I be paying only eight or nine cents to buy that 50? Or will it average out that I paid up 12-and-a-half cents as I work through all the levels? I don't know how someone's going to study that.

If some retail [investor] can sell at a three-cent spread that's great for him. But for us the question is, does it matter for a sizable ticket? It probably will…

The point is: Will narrower minimum quote spreads affect the pricing of larger block trades? Probably, but a comprehensive study will need to be done.

Andy Brooks Head Trader T. Rowe Price Associates

If you ask savvy people in the business how long we will stay at a nickel they'll say about 16 seconds before it goes to a penny.

I'm trying to understand what we're going to gain from going to a penny. Frankly, I wonder. I don't think T. Rowe Price would have a problem if increments stayed at a nickel. I wonder if the heightened volatility in this market is directly related to the narrowing of spreads. Maybe you're winning on the spread side, but you're losing on the volatility side. If that's true, then investors are worse off.

We've had a narrowing of spreads in the last couple of years as well as a tremendous increase in volatility. I think we need to be careful and we need to be thoughtful in how decimalization rolls out.

Gary Kaplowitz Head Trader Fahnestock & Co.

Prints will be smaller. It will take longer for customers to get in and out of stocks. It'll be a hundred shares every penny. It'll take you forever. You go out and try to sell 5,000 shares and everybody's buying a hundred, a hundred, a hundred…every penny…It'll never end. Everything will just keep moving. Think of how many people you'll have to go out and hit to get something done.

Because a penny won't matter there will be more guys on the inside. They'll only buy a hundred. It's ridiculous. When they think they're cutting down their risk because [the tick is a penny] you tend to see guys putting bids on different levels more quickly than they would if they thought they could lose an eighth.

It's just going to increase the speed of the stocks going up and down. There will be no real depth in the market.

Sal Dacunto Vice President, Equity Trading M.H. Meyerson & Co.

I have no problems with decimalization. We have already worked sometime with it on the Bulletin Board. It's just as efficient as the fractional system. However, for the mom and pop investor out there it's probably a lot easier for them to understand nickels and dimes rather than 1/32's or 1/16's.

Decimalization has worked for the Bulletin Board and I think it will work for Nasdaq. Spreads will tighten and therefore customers will get better prices; however, there may be a liquidity problem with tighter spreads. Market makers might not be willing to take the extra risk.

The bottom line is whatever the regulators want, right or wrong, they are going to get. So, let it come; we're ready for it.

Junius Peake Finance Professor University of Northern Colorado

Some stocks may have tick sizes of one cent; some may have three cents; some may have a nickel; some may have a dollar. I think the market will sort it out. The most widely traded securities may have a minimum tick size of a penny, but why should some government official or stock exchange official decide?

The minimum tick is a vestige of fixed commissions that didn't get eliminated in 1975 when fixed commission disappeared. It increases unnecessarily the cost of trading and any time you increase the cost you have fewer people trading. I mean it's Econ 101. If you reduce the price of something, people will buy more of it. That certainly worked in 1975. When fixed commissions disappeared, volume mushroomed.

Wes Cooper Former Nasdaq position trader) Senior vice president, Administration and Operations Advest Group

If the minimum price variation is a nickel, then there will not be much of an impact on Nasdaq spreads. But we will eventually move to one-cent increments for actively traded, highly-liquid stocks. Liquidity will not change.

Today, given the order handling rules and the minimum quote size of 100 shares, depth is already an issue. Decimalization could have a positive impact. I think that all of Nasdaq will move to an agency basis. I thought it would've happened by now.

Nasdaq traders are going to have to watch the tape for the trend and not the tick. It will become much more important to pay attention to the bigger picture. With quotes changing rapidly in one cent increments it will take more than one or two ticks to signify a trend.

Advest did not drop any stocks as a result of the order handling rules. We don't expect to with the implementation of decimals either. From an operational standpoint our prime concern is bandwidth. It must be more than sufficient to handle the increased OPRA [a subscription service that disseminates inside quotation and last sale data for options traders] traffic. Every time Microsoft moves by a penny it impacts every option in the chain. Decimalization will mean more data traffic lines. Firms may have to upgrade to T-1 and T-3 lines.

Buzzy Geduld President and CEO Herzog Heine Geduld

I have no crystal ball, but if the spread drops below five cents it will be detrimental to the market as we know it. It will go to a penny if the SEC lets the market decide. It will be the death knell for the principal business. A quote of $19.00 to $19.01 is not necessarily bad, but it will change the structure of the market. We will absolutely charge on an agency business.

There will be three ways to charge: on an agency basis; on a principal basis, predicated on what you charge for risking your capital; and by the spread. The customer will have a choice.

Early last month, an analyst at C.E.Unterberg, Tow- bin doubled his price target for a stock called Puma Technology, a communications software publisher. Puma Technology was planning an acquisition, putting it on course to duplicate Phone.com, a successful industry peer. That company has seen its stock price rise from about $30 to $230 since its initial public offering in June. (At press time, the acquisition was still pending.)

In what is becoming standard practice at many broker dealers, Unterberg Towbin launched a team-based sales assault on its buyside clients to spread the word of a potential new Phone.com success story. Sales trading coordinated its efforts with research and equity sales.

The strategy worked. By the end of the day, Puma had shot up $4.50, or about 25 percent from its prior-day close of $17 3/16.

"You can be sure that our sales traders made sure that the trading desks at major accounts had that message at the same time as the research sales force and the institutional sales force was delivering that message to their counterparts [at the same accounts]," said Mitch Meisler, Unterberg Towbin's executive responsible for coordinating the sales efforts of the three divisions. "As long as I've been in the business [team selling] has been the holy grail. It's what you hope for. It's what you aspire to."

Hoping to capitalize on the team-based sales trend, Thomson Financial's First Call has introduced an Internet tool called "Integrator" that supports a broker dealer's unified approach to account management. The product combines standard contact management software with database search capabilities. (Thomson Financial is the parent company of Securities Data Publishing, the publisher of Traders Magazine.)

The contact management application allows analysts, research salespeople and sales traders to access account information and to communicate with each other via notes. Contact management software is a staple among salespeople. ACT!, by Symantec, is the biggest seller in the U.S. of contact management software.

Integrator provides access to two types of databases: one with buyside contact data and another with institutional shareholdings data. The contact data includes the names of portfolio managers, analysts and traders at over 4,000 global institutions. Shareholding data consists of the securities holdings of those same money managers.

Both data sets have been on the market for years in various forms. Technimetrics and Nelson Information, both units of Thomson, sell the contact data. CDA Spectrum, also a Thomson unit, and Technimetrics sell the shareholding data.

The shareholdings database can be queried by the market capitalizations of the stocks. Queries can include the manager's investment style, such as growth or value and other queries can be by the sectors in which they invest, such as energy or healthcare; and by the global regions in which they invest. Users can also determine whether a money manager has been a buyer or seller of a particular stock over the most recent quarter.

Integrator's product manager John Murphy touts the ability of a sales trader to add a client's "interest list" to the system. An interest list includes those stocks an institutional trader owns and wants to monitor or those he doesn't own and may want to trade.

The product has been available since June and costs under $500 per user per month, according Murphy. Subscribers are likely to be small or medium-sized broker-dealers. Murphy says there are currently 400 individual users at "more than five" firms.

ABN Amro is one of those firms. It has deployed Integrator in its sales and research departments, although not in its trading department.

Brendan Toulose, an equity salesman in ABN Amro's New York office, says he gets the most from the shareholdings database, adding that a sales trader should as well.

"With the click of a mouse everything is there," he said. "Previously we had piles and piles of paper. Now if I want to find out what's in Scudder's Science & Technology Fund, for example, I just type in the request and click the mouse."

Toulose says he finds little use for the software's note-passing function as he is in constant contact with his firm's analysts. He hasn't found much reason to access the buyside contact data either.

Despite the exclusion of ABN Amro's sales traders from the product, industry executives say it is vital for the sales trader to be included in the research pitch. "In this world you want the message to get to the account," Meisler said. "Whether it gets to the ultimate trigger point from the trading desk or whether it goes in through the analyst or the portfolio manager, you want to have all sides armed with the information, so that one way or another the message has gotten through and someone can react."

Paul Mazzarella, the head of sales trading at Boston's Adams, Harkness & Hill, says the team-based approach is more often found at small shops like his.

"Adams, Harkness is not an execution firm like a Morgan Stanley or a Salomon Smith Barney," he explained. "But what we lack in capital we make up for in our ability to act quickly in the dissemination of information. We are nimble. Our research department keeps our sales traders informed. It is important to us that we are working on all cylinders to reach our customers."

Adams, Harkness does not use Integrator, but does use Spectrum shareholder data. ABN Amro's Toulose uses both, but calls Integrator's technology "superior."

That technology is known as Internet database publishing. Data is exported from a database to the HTML, or hyper-text mark-up language, document format. HTML is the coding used to create web pages. Web surfers encounter database publishing when calling up news stories on the websites of media companies or when searching a site for cheap airfares, for example.

First Call's publishing system for Integrator is based on Microsoft technology and runs on its Windows NT operating system. A sales trader uses his browser (Explorer is recommended) to access the Integrator application at a First Call website.

Working behind the scenes in support of Integrator is Microsoft's web server software, Internet Information Server (IIS) 4.0. Web server software takes requests from Web browsers to download HTML pages. IIS 4.0 works in conjunction with a Microsoft innovation called Active Server Pages. It executes scripts, or small programs, that automate database searches.

The data itself resides on Microsoft's SQL Server 6.5, a database management system (DBMS). A DBMS is software that controls the organization, storage, retrieval, security and integrity of data in a database, according to CMP's TechEncyclopedia. It accepts requests from applications like Integrator and instructs the operating system to transfer the appropriate data.

"The sellside wants to harness technology that can help it contact its counterparts on the buyside with lightning speed and with impact," Unterberg Towbin's Meisler said. "It [Integrator] helps leverage the efforts of the sales force and the sales traders to reach accounts that much quicker… that's what it's all about."

The days of processing a securities transaction in a batch cycle are long gone. Nowadays, straight-through processing, or STP, is the objective for securities trading firms. Competitive pressures demand faster order and execution turnaround, immediate access to best execution liquidity sources and timely and efficient settlement processing.

At the heart of STP is a message switch. That switch is part of a message routing network.

Message switches perform an indispensable middleware function by allowing the retention of legacy back office systems and providing a single access point for customers and exchanges. (The switch must operate in an "open" systems environment in order to be effective.)

A variety of transactions, primarily requests for quotes, data look-ups, order routing and trade notification or comparison, must be performed by the parties involved in processing the trade. By using a centralized and controlled approach to message switching, client applications assist this function.

Now let me discuss other sub-components of STP.

The client side is where the messages are created. As you know, equity traders face two challenges: connectivity with sources of liquidity and connectivity with their clients. The FIX protocol is a popular strategy for connecting institutions and brokers. Still, FIX faces its own challenges – as a trading and deal capture system at each end and as a reliable and secure network.

Connectivity for investors, whether through proprietary front ends or Internet accessible Web servers, places new demands on legacy processing systems. The delivery of information may be provided more cost effectively with STP. PC and Web-based connectivity systems are proven business getters.

So where does the message switch fit in? Coupled with open systems, the message switch provides a modular architecture that enables financial institutions to add electronic connectivity while maintaining their investment in back office systems.

Davidge Data Systems provides a Data Communication Applications Programming Interface (DCA) to intermediate FIX-based message structures. This is accomplished at the communications level on the message switch while the institution's FIX system is virtually untouched. For proprietary system messages, Davidge Data distributes interfacing tools like messages, API's and class libraries, which serve as message translators at the institution's trading system.

Historically, listed equity and options exchanges offered automated execution systems. Exchange connectivity is established using communications and message standards that have evolved in an ad hoc fashion. The consensus message standard is the Floor Communications Standard (FCS). The format mimics the data in a paper ticket.

One of the moving forces behind the rapid acceptance of electronic communications networks is the adoption of FIX. The message switch is again a vital cog in disseminating the different exchange formats and communications protocols by providing a layered architecture.

The top layer interfaces with the message routing network. Next comes a middle layer for table-based text substitutions as a message intermediary. Finally, the lowest tier is a configurable communications interface that supports multiple protocols.

It is also important that the message routing network support outbound API's. That's because many brokerages may wish to support in-house market making activities and field new products. Typically, the broker's clearance and settlement system submits the executed transactions to a depositories' and exchanges' comparison systems.

Today's regulatory environment demands an intra-day submission and comparison. The National Association of Securities Dealers uses real-time messaging with its ACT comparison system. The listed exchange systems have moved closer to real-time with T+3, and are now preparing for T+1.

Meanwhile, brokerages still face many challenges in converting their batch submission legacy systems. These have been converted to "intra-day" submission systems as a result of T+3, to more message-oriented processing in to get ready for T+1.

In the end, the goal is to have a single firm-wide message routing network allowing a firm to maintain its legacy trade processing system and customer accounting system. Here are the steps: The message switch takes in trade notifications from both customer and street sides and submits these to the firm system. Finally, the message switch integrates the firm's system interface to comparison submission on a message-oriented, real-time basis.

That's STP, as you might say, at work.

Nick Davidge is the chairman, founder and chief executive of New York-based Davidge Data Systems, a provider of connectivity solutions to the securities industry.

Paul Hennessey, a retiring veteran buyside trader and executive, has seen it all and survived it all in the last forty years. And lots of things have changed in that period.

He has seen money management go from a business exclusively for the well-heeled to one that serves a mass constituency; one in which the average investor can wield institutional influence through the power of defined contribution plans and other giant retirement plans with billions of dollars in assets.

He has seen fixed commissions become history; brokerage rates and trading costs decline dramatically. But most of all, he has witnessed the beginning of a technological revolution in the trading business.

The former Eaton Vance trader, who four years ago helped found his own-Boston-based firm, will retire by the end of the year. He will spend more time with his children and grandchildren in his Beverly, Mass. home. But although Hennessey says that his pace may slow down a little, the pace of technological change in the trading business will not.

The next two years will be critical for electronic communications networks (ECNs), says the veteran trader and executive. How will they handle the expected 2000 crisis at the same time that decimals are coming to the industry? What happens if expected computer foul-ups – the putative Y2K nightmare that the big media continues to prattle about – cause a bear market next year? Will the regulators or officials of the traditional market exchanges squash ECNs?

"I think ECNs are probably here to stay, but there are going to be some big changes because there will be some big challenges," says Hennessey, a principal of Boston Partners Asset Management, a trading firm with some $14 billion under management and four traders.

Although Hennessey is retiring, he still is very interested in what will be happening in the trading world.

First, ECNs will survive any Y2K problems, but there will be fewer of them. "I think we will get down from nine to five or four next year, then two or three over the next three years. There's not enough business for everyone. And only the strongest are going to survive, which means those that offer the best prices to money managers," he warns.

Hennessey's Darwinian reasoning is that there is not enough business to go around and that the big boys – the 800-pound gorillas such as Merrill Lynch, Goldman Sachs – are buying pieces of ECNs. Will ECNs even be around in the next few years? Or in what form? Hennessey says the big boys are preparing for all possibilities.

Second, Hennessey says ECNs have yet to be tested by bad times. Only some rocky periods for ECNs, he says, can provide critical information about their future.

"It is in bad times we are going to find out if ECNs are just a function of bull markets. Will there be enough volume to survive a bear market? Are investors really going to want to trade after the market closes when the market has been going down?" he asks.

Third, ECNs will face challenges from regulators and competitors, he predicts. Rival marketplaces will either try to liquidate them or incorporate ECNs, he adds.

Fourth, despite all the fuss and feathers about ECNs, their impact has yet to be fully felt in the business. ECNs have yet to make trading costs cheaper, he says.

"I don't think ECNs have caused any significant lowering of institutional rates because there has yet to be significant penetration. However, the potential is there in the future," he adds. That potential, he says, will trigger as profound a change in the industry as the one that came out of May Day in 1975, which ended fixed commissions.

ECNs will continue to dramatically change the industry, although the extent of the change is still to be determined, Hennessey says. However, the more things change, the more they stay the same, he notes. Regardless of technology, the qualities that make a good trader haven't changed in the last four decades.

"Good traders must have a competitive personality. They must be able to assimilate a lot of factors and make quick, accurate decisions," according to Hennessey. "A good trader must also have the ability to understand the other guy; to understand the client and what the client wants."

Those traders with these considerable talents, Hennessey says, will also survive no matter how radically technology changes their business.