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The Bell Tolls for the Big Board

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Island, Instinet, Archipelago, and the other alternative markets have three big advantages over the Big Board, as Andresen eagerly explains. First, trading on Island costs about 75 cents per 1,000 shares, instead of as much as $1 for 100 shares on the NYSE. Second, Island eliminates the edge that specialists and cunning brokers have by making the whole list of limit orders -- how many shares of Johnson & Johnson to buy or sell, and at what price -- available on any investor's computer screen via the Web. Island only takes limit orders, and the only way to get to the front of the line is to submit a better price, and after that, it's strictly first-come-first-served. Third, everyone has the same degree of anonymity (no names on the screen) and visibility (the size of every order is on the screen as soon as it is entered).

The catch is that, without brokers, big investors need to do their own strategizing about how to trade and what to show the screen. And without specialists to keep the market moving smoothly, investors face the prospect of choppy price swings that can raise costs dramatically. In October 1987, the last time there was a major stock-market rout, some big trading houses on the NASDAQ market simply stopped answering their phones rather than face a deluge of sellers, and liquidity dried up. But Andresen, who was in the eleventh grade in 1987, says he is isn't worried.

"The fact is that the specialist really only trades when it suits him. Do you have to tip the scales so far in their direction in order to compensate them? In an electronic market with ease of entry and exit, with the whole world looped together, there are going to be opportunities for lots of dealers to step in and keep things moving. Why not have them compete on a level playing field, where everyone can see all the orders?

"Maybe Grasso will build his own electronic network and crush us like a bug," Andresen says. "But his members have no incentive to innovate, so maybe we will be able to move faster than his members are able to react."

Grasso remembers well the market rout of 1987. On October 19, the Dow fell 500 points, and the next day, the NYSE's volume hit a record 608 million shares -- double its previous peak. "When that wave hits again," Grasso says, "all of this playtime around the perimeter -- the electronic communications networks, the alternative trading systems, the new cyber-trading models -- they had better provide value. My guess is, they won't."

As the exchange executive overseeing the trading floor in the late eighties, Grasso spearheaded a controversial effort to increase its capacity five-fold, including the addition of the Superdot system. "There was a time when people on the floor said that system was an absolute end to our business," Grasso says. "They fought it, and they fought me. Some of them aren't around anymore. But the ones who embraced the technology have never done better."

Grasso's spent his entire career climbing the ranks of the exchange's staff. "It's my first job and my last job," he says. He never knew his father, who abandoned the family, and he was raised by his mother and her sisters. (One woman was a paper-box maker, another a seamstress; the third kept house.) He grew interested in finance during high school, when he got a job for the neighborhood pharmacist, who traded stocks all day while Grasso filled prescriptions. He also failed the eye test to become a policeman. So, after a stateside stint in the Army, in 1968 Grasso found a job on the New York Stock Exchange staff. He started out angling for a job at a specialist firm and enrolled at Pace University at night. But he never finished his degree or became a dealer. "I fell in love with the exchange," he says.

At 22, the exchange sent him with John J. Phelan, a powerful specialist, on a tour of its listed companies to explain the strength of its system. Flying with Phelan around the country, Grasso became his protégé -- Grasso still calls him J.J. -- and had a chance to schmooze the chief executives of the biggest companies in the U.S., at a time when few in the exchange had contact with the outside world. When Phelan became chairman in 1984, Grasso was his right-hand man as he sought to professionalize the NYSE's management. Phelan kept a plaque outside his door bearing a quote from Machiavelli: "There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things."

As chairman, Grasso stepped up efforts to build the NYSE's brand name. He encouraged CNBC and CNNfn to broadcast from the floor. And he threw himself into promotional stunts like getting coated with green slime with Kelsey Grammer and parading the floor with Cindy Crawford and Mariah Carey -- all in the name of promoting the listed companies, he insists. More than one floor broker, though, has speculated that Grasso wouldn't mind the attention he stands to receive as the first chief executive of the publicly traded NYSE, Inc. (To say nothing of the potential pay raise.)

This spring, Grasso bewildered the trading floor by shaving what hair was left on his head -- a style he borrowed from Andresen. Then he surprised them again by flying to the jungles of Colombia to extol the virtues of the free market to machine-gun-toting Marxist guerrillas. (He was introduced as "the president of capitalism.") A few weeks later, he ran into Frank Zarb, head of the NASD, at a meeting in Washington to discuss after-hours trading. Diagnosing "a serious midlife crisis," Zarb handed Grasso an orange wig. Grasso, too, had come prepared. He gave Zarb a photo of his Colombian encounter doctored to impose Zarb's laughing face on the comandante. "The only thing I don't like about this picture," Zarb told him, "is, it makes me look shorter than you."

Zarb and Grasso are the friendliest of sworn enemies. Zarb, 65 years old, also grew up in a family of Italian immigrants, in Flatbush. He had begun to make a name for himself training gas-station managers to do paperwork when, in 1962, a young man named Sanford Weill invited him to help organize the back-office of a new firm. Other partners included Arthur Levitt, Arthur Carter, Roger Berlind, and Marshall Cogan. In 1997, after a career bouncing between Washington and Wall Street, and another job working for Weill -- Zarb headed Smith Barney, and Weill headed its giant parent company, Travelers -- he received a call from his old friend Levitt. Levitt, now chairman of the SEC, asked Zarb to take over as head of the NASD.

The NASDAQ is still a fifth the size of the NYSE, but Zarb has annoyed Grasso by retaining five of the most heavily traded companies -- Microsoft, Intel, Dell, Cisco, and MCI WorldCom. There is no NASDAQ "exchange." Instead, it is simply a group of securities firms that act as "market-makers" by constantly posting (lower) bids to buy and (higher) offers to sell NASDAQ-listed stocks, like currency exchange booths at the airport. Investors have to trade through market-makers, who pocket the spread between their bids and offers. They have a good deal: NASDAQ market-makers have the same advantage over their customers that specialists do -- they see all the orders coming in. Competition among several market-makers in each stock is supposed to keep them honest.

On August 27, Zarb was pacing his Washington, D.C., office in front of a wall dedicated to newspaper cartoons of himself. He was preparing to announce that afternoon that part of the NASDAQ system would stay open after hours -- a concession to the new alternative systems. The new electronic networks have already stolen business from his other member firms, and now, as they connect with each other after hours and register as independent exchanges, they are beginning to endanger the centrality of the NASDAQ network itself.

Zarb has his own membership problems. He has tried in the past to build an automated electronic NASDAQ exchange, but his member firms stymied him, telling the SEC that the NASD shouldn't compete with them at the same time that it regulates them.

Now, though, Zarb says NASDAQ is about to strike back against the new electronic networks by building a computerized central order book of its own called "supermontage." Investors will still need to trade through dealers, but the market-makers will no longer have an information edge over everyone else. Zarb says most of the firms realize their current position is untenable in the long run. "Sure, they'll take that as long as it lasts -- and some of the firms lobbied mightily against us when we tried to change it before -- but they know damned well it is not going to last," he says. "Securities firms have lots of ways to make money. I'm not worried about them." Like Grasso, he has proposed taking the organization public to gain more flexibility. It would also let him pay off his firms (and biggest companies) with shares. "Grasso knows that we are going to be cheaper and fairer," Zarb says. "He knows he has to respond."

"Aside from five great companies, I don't really see what Frank has got that I don't have," Grasso says, sitting forward in his office armchair. Indeed, Grasso knows his real problem is not his competition: NYSE's size, liquidity, and reputation for integrity are unrivaled. Its financial resources match anyone's. Grasso's dilemma is the exchange itself, a problem that is more complicated because it is more human. To maintain the NYSE's place at the center of the financial world, Grasso knows he, too, must now compete with his biggest member firms. And he must sell his individual members on technology that could evacuate the trading floors and make them obsolete.

Asked what the future entails, Grasso talks quickly, rattling off slogans about "continuously implanting technology" and "a seamless process from the end customer to the point of price discovery and back."

At heart, though, his vision is simple, if risky for his members. The centerpiece is a giant electronic-trading network, much like Island -- accessible electronically from anywhere, with all the orders equally visible to everyone on and off the floor. But there will still be a trading floor, Grasso insists. There human brokers will wander around toting handheld computers -- souped-up Palm Pilots, essentially -- zapping trades into the system and beaming the "look" back to their clients. He sees a place for specialists too. Wrapping the new electronic network in the envelope of the current human system, he says, will maintain the security of a dealer's intervention in a pinch. (Specialists will no longer have an information advantage, but they hope to get paid for their services in other ways besides their own trading profits, such as special commissions.)

Why pay a floor broker when a seat on the floor no longer provides privileged access to trading or the order book? Relationships, Grasso says, and the trader's time-honed art of gauging and gaming his fellows. "If you are a seller of 10 million shares, you'd better not tell the world that by entering it straight into the system," Grasso says. "Then every buyer in the world will suddenly have an information advantage -- they'll all wait until the price sweats to the bid side. It's not as simple as throwing everyone's bid and offer into a washbasin."

Still, floor brokers will have their work cut out for them in selling their services to investors. "Why should I pay somebody just to break up my order? A computer can do it for me," says Harold Bradley, of American Century. "Why pay a middleman to do what technology lets me do myself? The New York Stock Exchange is like the Berlin wall -- for decades, everyone said it was crumbling and predicted it would fall. Now they take it down overnight, and people say, Can you believe it?"

Entering the largest of the four rooms on the floor, McSherry points behind us to a special electronic ticker that displays the most recent bids and offers for exchange seats -- the most closely watched display in the room. Seats are trading at an all-time high, a sign that the market believes Grasso can pull it off. "Some of that is Clinton and Greenspan, but much of it is Richard Grasso," McSherry says.

But the people on the floor still can't help wondering if their business can survive in Grasso's vision of an electronic and publicly traded NYSE. "There will be no reason to be down here," says Olsen, a broker who has worked on the floor for 37 years. "It will be the end of the auction system."

For his part, McSherry is more optimistic. "Mostly we are taking a wait-and-see approach," he tells me. "I think a lot of investors would like to own a little piece of the New York Stock Exchange." It's almost as if he had the Berlin Wall in mind.


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