Starting at around 7 a.m., the 1,315 men and 51 women who trade on the floor of the New York Stock Exchange pour into its Corinthian marble façade, more or less as their predecessors have done for nearly 100 years. While a handful are in standard Wall Street power regalia – heavy cuff links, bespoke suits – most of the traders who work on the floor dress like tabloid reporters: They wear jackets and ties because they have to, not because they mean it. Upstairs, in a coatroom off the hallway of the exchange’s wood-paneled dining club, many check their sport coats in favor of mesh-backed canvas jackets, because it can get hot running around the floor, or shove their wing tips into cubbyholes to don rubber-soled shoes, since the wooden trading floor can devour shoe leather. By nine, dozens of brokers have drifted back out onto the sidewalk on Broad Street to smoke their last cigarettes before the 9:30 opening bell. Smoking is a relic of the past among the investment bankers and lawyers of Wall Street, but it is still widespread among the Big Board’s floor brokers. The Exchange is an anachronism in many ways, the last redoubt of face-to-face human interaction in a digital world. It is still a place where a bright kid from the boroughs who never went to college might land a job as a clerk and grow up to make more than $1 million a year.
But after the 4 p.m. closing bell on Monday, August 2, all that began to change. In the first of three carefully scripted meetings that week, about 400 members gathered in the gigantic boardroom on the NYSE’s luxurious wood-and-carpet executive floor – a world apart from the fluorescent lights and paper litter of the teeming trading floor. Standing under a stained-glass skylight in the chamber’s 70-foot-high ceiling and surrounded by oil paintings of the NYSE’s former chiefs, chairman Richard A. Grasso told the assembled members that the Big Board could no longer hold out against the Internet’s sweeping transformation of Wall Street. In the past two years, a handful of fast-growing new electronic “alternative trading systems” had begun threatening to replace the exchange with cheaper, faster, and arguably fairer automated networks capable of matching buy-and-sell orders and finding prices for stocks. To compete, Grasso said, the NYSE had only one choice: to buy or build a new electronic network of its own. “These have been the best five years in our history,” he told them, “and if you take the time to celebrate, you die.”
The brokers shifted in their chairs, struggling to imagine just what Grasso had in mind. A short, bald man in thick rimless glasses, Grasso is nobody’s picture of an inspirational leader. The members had watched warily over the last few years as electronic trading eliminated smaller trading floors in London, Paris, and elsewhere. Grasso was pushing a plan that the members knew could put many of them out of business and end a 200-year-old way of life.
Since its founding in 1792 under a lower-Manhattan buttonwood tree, the NYSE has operated as a not-for-profit organization owned by its seat-holding members. They consider it a public utility, as well as a handsome living for themselves. Now, Grasso told them, the Big Board needed to sell shares in itself to the public as a for-profit corporation to help finance its new high-tech investments. He had previously resisted the idea, fretting that a public company might put short-term profits over investors’ long-term interests. Now Frank G. Zarb, head of the National Association of Securities Dealers, had announced plans to sell its NASDAQ stock market to the public for similar reasons. If the NYSE didn’t keep pace, it would risk losing its place as the center of the financial world.
Many floor brokers had their doubts. They knew that converting to corporate form would eliminate much of their control over the Big Board’s future. “Once you start doing it on a computer, all this will disappear – there is no reason to have a floor,” says Paul Olsen, a longtime broker. “For 200 years, the members have been able to solve all our problems with the staff, and now the Internet comes along, and they want to make the whole thing electric – it’s bullshit.” “It will put a lot of people out of work and clear a lot of taxpayers out of New York, that’s for sure,” says Robert Hardy, another broker. Grasso didn’t say it, but the audience also knew that the exchange didn’t need to sell shares to raise money. The NYSE ended last year with more than $700 million of cash on its books, and it could charge the costs of an electronic trading system to members and their deep-pocketed Wall Street firms. These facts gave rise to speculation as to Grasso’s real motives. Was the IPO essentially a gambit by Grasso to pay them off to get out of the way, by giving them a chance to cash in their seats for shares?
The members exercised their occupational habit of making quick calculations in their heads. Priced at the same multiple to its earnings as the average stock in the Standard & Poor’s 500, the NYSE, Inc., would be worth roughly $3.5 billion – almost enough to equal the total current market value of all its members’ seats.
In a heated question-and-answer session, one member asked a string of seven questions about the future value of his seat; Grasso addressed them in order from last to first, impressing the members with his memory and command of the details. The first Exchange chairman to work his way up through the institution’s staff, Grasso had spent 31 years schmoozing with members. He had gotten to know most of them by name, chatting with them on the floor or over bacon and eggs in the exchange dining club. Now he was relying on all of the goodwill he’d built up over the years to bring the exchange’s members into the terra incognita of electronic trading. It was a Nixon-in-China moment, and Grasso carried it off. He told them that the NYSE’s board would retain Merrill Lynch on a pro bono basis to report back on the possibility of an IPO. Meanwhile, the NYSE might take steps toward building or buying a new electronic network at any time.
For Grasso, a 52-year-old college dropout from Jackson Heights, the next five years are a chance to write history. The advent of electronic stock trading – not just placing orders online through E*Trade for execution by a human broker but electronically matching orders and finding prices – is revolutionizing the way stocks are traded. Electronic networks already account for 30 percent of the trades on the NASDAQ; only NYSE rules have protected its volume, by hindering connections to its market and restricting its members’ firms from trading its shares elsewhere. The trend toward automated electronic trading promises to dramatically lower the bite Wall Street takes out of investors, from brokerage commissions to mutual-fund expenses. Automated systems operating today charge less than a quarter of the fees an NYSE broker does, and they can provide investors much more direct access to the markets. To prepare, the firms with the most seats on the NYSE floor are becoming its competitors. Goldman Sachs, Morgan Stanley Dean Witter, Salomon Smith Barney, and other giant NYSE-member securities firms are investing in its upstart electronic rivals. Even Merrill, the NYSE’s IPO adviser, acquired a 14 percent stake in Archipelago, an alternative trading system based in Chicago. Several of the upstarts are now applying to the SEC to become self-regulating “exchanges” themselves.
The pace of change is quickening. Last week, the Securities & Exchange Commission’s chairman, Arthur Levitt, threw his own considerable weight behind electronic stock trading and effectively challenged the NYSE to prepare. In a speech at Columbia University, he outlined a vision of a national electronic stock-market system, in which several exchanges compete with each other to execute investors’ trades. To bring it about, he discussed reforming the rules that give the NYSE a near-monopoly on trading many of its listed stocks. And as soon as this week, Frank Zarb is expected to launch another salvo in the war as well – a new electronic system sharing information about orders among investors and dealers in the NASDAQ stock market.
Leaning back in an armchair inside his palatial office in the Big Board’s executive suite, his French cuffs dangling loosely around his wrists, Grasso talks about his approach to the members like a tough parent bringing up sometimes shortsighted kids. “Sure, the changes now are going to be wrenching, and of course change is resisted,” he says. “But the one thing they understand down there is winning. I tell them, if you think you are going to do business in ‘01 the way you did in ‘99, you are woefully wrong – not wrong for me; wrong for you, for your kids, and for your grandkids. You know, no matter how good a blacksmith you were at the turn of the century, if you wanted to remain a blacksmith, you were in trouble.”
But Grasso also knows he has to be careful, because any major change needs the approval of two thirds of the members. “I want you not to get the impression that I am in the business of cannibalizing the current model – I am in the business of reinventing it,” he says, slipping back into his everyday role as the NYSE’s salesman-in-chief. “This place is very different from anything else on the face of the earth, different from any of those exchanges in Europe. We bring together 70 million investors – some are massive, some are minute, but they rank equally, they have the same speed of access to prices, they have the same opportunity to compete for execution. Is there a piece of software that can replicate what we do here? Not right now. Is there going to be? Probably. And if anyone is going to deliver it, it is us.”
Aside from talk of the possible IPO, the summer of 1999 was the quietest in recent history on the NYSE trading floor, says Bernie McSherry, a longtime floor broker, as he walks briskly through a maze of brokers’ booths, trading posts, and telephone clusters mounted on poles. It’s early in the day, but the floors are already strewn with paper, and uniformed staff are carrying out the first of many trash bags full of empty Coke bottles, chewing-gum wrappers, and foam cups. The fluorescent and halogen lights cast a ghostly glow over the tourists looking down from behind glass in the galleries above. An ancient POW-MIA flag hangs on a wall, a nod to the large number of veterans working on the floor.
McSherry, a boyish 42-year-old with a round, reddish face, is the son of a Staten Island police officer. When he was in accounting school at Staten Island’s Wagner College, a friend got him a job as a clerk at the American Stock Exchange. He graduated and found work as an accountant, but on his first day, he quit out of boredom. “All I could think about was how much fun I was having back on the floor,” he says.
The small securities firm he worked for eventually moved him to the NYSE. After the crash of 1987, the firm “got cold feet,” so McSherry persuaded it to spin him out as an independent and let him assume the lease on his seat. (Many floor brokers own their seats, which carry the right to trade on the floor and these days sell for about $2.6 million; others lease from inactive members who live off the income.) The $13,333 a month in seat rent was tough at first. He spent $2,000 on a week’s vacation with his family at the Grand Canyon and couldn’t help thinking that his empty seat was costing him another $3,333. (Seats lease for about $250,000 a year today, and since no one else can use a seat while a broker is off the floor, even smoking breaks can be expensive.) It was rough going, McSherry says, until a former colleague joined a major investment firm and began sending him trades.
The roughly 400 independents like McSherry are known as $2 brokers, because their commissions were once fixed at $2 per 100-share trade. Congress ended fixed commissions altogether in 1975 as part of the legislation that set in motion the competition among brokers and markets now roiling Wall Street. Today, commissions on the Big Board are negotiated with each client. They typically run about $1 to trade 100 shares for a client, but they can run below 30 cents per 100 shares for a big institution. The best $2 brokers are highly sought-after and make the most money on the floor, pocketing well over $1 million a year in good times, even after the expenses of leasing a booth on the floor and paying clerical staff. “House brokers” who work for firms like Merrill or Goldman are paid a salary of about $150,000 a year as well as a hefty incentive bonus.
Trading on the floor is “a relationship business,” as any broker will tell you. It’s based largely on trust; many brokers do $100 million in business a day without signing a single contract. Honoring oral agreements is the easy part, however. The art of trading, on the floor as elsewhere, is about information. Every time McSherry approaches another broker with a bid to buy or an offer to sell shares, he makes himself vulnerable by revealing his intentions. The other broker could trade ahead of him, taking advantage of the impact his buying or selling will have on the price. (You’ve got a big order that will bid up the price? Maybe I’ll just buy some first …) If McSherry has been a buyer in a stock, a friend may track him down when an order to sell comes in, even if McSherry is out grabbing a smoke. But a spiteful broker will take the trade elsewhere if he can, embarrassing McSherry in front of his client. “There have been vendettas between brokers down here that have lasted whole careers,” he says.
The striptease of concealing a client’s intentions is a broker’s most important skill. If a client wants to sell 5 million shares of Lucent Technologies, McSherry might split it up, selling it piece by piece so potential buyers don’t see the magnitude of the sale. If they sense its size, buyers will pull back; his sales are likely to lower the price, letting them buy more cheaply later. A large trade’s impact on the price of a stock can add much more to a big fund’s trading costs than paying a broker’s commission. “You have to understand how someone you are trying to trade with operates,” says Joe Cangemi, a floor broker who got his start in the business from the NYSE member whose lawn he used to mow growing up in Queens. “I might tell a client, Don’t buy now, this guy is a sloppy seller, he is going to do a bad job and it will hurt the stock. You’ll get a better price later.”
Which leads to a broker’s other key skill – figuring out what the other guys are up to. Sometimes, it behooves a broker to execute a big order all at once, depending on the market. Good brokers provide clients what is known as a “look,” a quick snapshot of activity on the floor, a sense of who is buying or selling what and how much. It comes from knowing what other brokers are doing and who they tend to represent. “That is one of the big services we provide,” says McSherry. If a large fund gives a $2 broker a big order to buy Merck, the broker will sometimes warn other favorite clients who call about Merck that he has “a size buyer,” so they know not to sell right away – they stand to get a higher price after Merck is bid up. This is a breach of fiduciary duty, McSherry says, but traders who call the floor say it happens all the time. (Distrust is a part of the system, too: From a portfolio manager to his trading desk to the brokerage firm to its trading desk, and all the way down to its floor broker, everyone splits up orders and tries to hide their size, in an effort to prevent leaks. “Sell these and let me know how it goes” is the standard refrain. “I might have some more later.”)
Thus, a floor broker’s craft takes a knack for “multitasking,” McSherry explains. “See that guy over there?” he says, pointing twenty feet away. “While we were talking, I just heard him say, ‘Sell 10,000 LU.’ It’s just a skill you develop. At a cocktail party I follow four conversations at once. It drives my wife crazy.”
The web of relationships is further complicated by the fact that a surprising number of the brokers on the floor are related. “I used to know 50 blue-blood-type guys, who inherited their seats from their dad,” McSherry says, as we stroll the floor. “There is less blue blood now, but there are still a lot of fathers and sons in the business.” There is almost nowhere else to learn floor-trading skills, and to get even a clerical job on the floor it helps to know someone. As a result, there are a lot of cousins trading with cousins. Some families, like the Hendersons, the Schuberts, or the LaBranches, have been on the floor for generations.
The elite among the traders on the floor – and the best or worst aspect of the NYSE’s system, depending on whom you ask – are specialists, members who are assigned by the exchange to manage trading in each particular stock. Essentially, they’re auctioneers. Robert Seijas, who helps manage Fleet Bank’s operations on the floor, is the specialist for Johnson & Johnson, or, in the parlance of the exchange, “Johnny John.” Each morning, after a quick swig of mouthwash – “an essential part of the face-to-face auction system” – Seijas takes his place in front of a teller-style window in a round kiosk on the floor of the exchange, surrounded by computer screens pointing in all directions.
All trading in Johnson & Johnson takes place at Seijas’s post, right in front of him. Brokers trade with each other, or hand him slips of paper with orders to buy or sell if the stock is at a certain price (limit orders). He displays the best bid to buy or offer to sell, and a clerk keeps track of the trading behind the window. Floor brokers try hard to stay on Seijas’s good side because, in a world where information is the key to success, a specialist has the most. “I work hard on my relationship with the specialists,” McSherry says. “If I’m a seller, a specialist can say to me, ‘Goldman was buying yesterday when the stock was at 42, and it’s around 42 now, so they might be interested.’”
The virtue of the specialist system is that Seijas is expected to step in when there is an imbalance of buyers and sellers in order to keep the price of the stock moving smoothly; they help make the Big Board much less volatile than the NASDAQ. The controversial aspect of the specialist system, however, is that specialists are allowed to use their unique vantage point to make as much money trading their assigned stock as they can. The exchange enforces certain fairness rules – a specialist, for instance, can’t ever step in front of another broker who wants to make a trade. And the advantage isn’t perfect: These days, specialists also customarily show their electronic order book to any floor broker who asks, and, consequently, brokers reveal as little as possible in the book. But seeing all the orders first is still an edge similar to being the only poker player at the table who gets to see the next few cards coming up in the deck.
Specialists are only required to maintain enough capital to buy at least 25,000 shares of a stock – just a tiny drop in the bucket of most companies. Some also wonder how much price stability they could provide in a big downturn; their capital hasn’t kept up with the growth in the market, and if they can’t keep the markets moving smoothly, why give them such a trading advantage?
By 9:45, Seijas has bought 8,000 shares for his account at $97.50 a piece, and the price has fallen 25 cents – four sixteenths, known as “teenies” or, occasionally, “steenths,” on the floor. The price is going down, but Seijas can’t unload his shares even if he wants to because a broker from Merrill Lynch is loitering in front of his station, and every time an order to buy shows up, she sells. (By waiting for buy orders, she can sell at the price of the best offer rather than capitulate to the prevailing bid.) Finally, she is done selling, and when the next big bid comes in, Seijas turns to me, “Should I sell now or hope the price moves up?”
I swallow hard and try to demur, but he insists. Sell, I say, breaking a sweat. He does. Thirty minutes later, the price is back up to $97.5625 a share – up a teeny from where he bought it. But with my help, Seijas managed to unload them down four teenies. “That’s a stone-cold loss of $2,000,” he says. “Get a hunch, lose a bunch – you can’t stress it. You should try it when there are a few more digits.”
Seijas proudly shows me the Big Board’s biggest concession so far to electronic communication – a computerized system called Super-dot (for “designated order turnaround”) that can send orders of up to 99,999 shares directly to the specialist’s computerized “book” of orders, without passing through the hands of a floor broker. Completed in the eighties, Super-dot took nearly a decade to fully install, in part because members fought it fiercely; it wiped out a whole echelon of brokers who made their living handling mainly small orders. Today, 90 percent of the NYSE’s orders come in through dot, accounting for 45 percent of the shares that trade. “The independent brokers who make their living on order overflow still have very mixed feelings about it,” Seijas says.
Critics of the exchange, though, note that dot just brings the orders to the floor without actually executing them. Seijas must open dot orders up to any floor broker who wants to buy or sell to them, but orders are visible only at his post, not off the floor. As a result, dot orders become “free options” to the floor crowd – they have an instant information advantage over the person who sent the order in. For that reason, few send large trades over dot, and critics say that even when it has modernized, the exchange has taken care of its own.
At noon, Seijas retires to smoke in a slightly run-down barroom attached to the exchange dining club – wood-paneled walls, leather-upholstered chairs, and yellow paint peeling around an electrical outlet in the wall. Specialists, he explains, are actually involved in trades that account for less than 15 percent of the volume on the floor; brokers meet each other directly the rest of the time. But it is the presence of the specialist to provide liquidity – that is, make sure it is never too hard to buy or sell any stock – that is the hallmark of the NYSE. “The New York Stock Exchange is the Mercedes-Benz of stock trading,” says Joel Surnamer, Pfizer’s specialist, who joins Seijas in a smoke. Although its fees are high, the NYSE saves investors less-obvious costs, like volatile prices. The big brokerage companies push the new trading systems so they can make money matching orders themselves, Surnamer says, but they still want to use the NYSE’s fair prices and fall back on its liquidity in a pinch, essentially hitching a free ride on the NYSE’s system.
Investors and traders off the floor, however, often grouse that the human element of the NYSE is maddeningly fallible. None complains as vociferously as Harold Bradley. Bradley sits halfway across the country from the canyons of Wall Street, in Kansas City, managing a portfolio for the mammoth American Century Investments. “The NYSE makes it so needlessly complicated just to put the peanut butter on the bread!” he tells me over the phone. “Everyone in the whole bucket brigade that handles my order takes a cut, and each of them has a chance to tell five other people!” Bradley and some other fund managers have petitioned the NYSE for years to show the specialists’ order books to the public and automate more of the process. “Brokers are just toll-takers. They should get shares for their seats and go sit on the beach,” Bradley says.
One reason Bradley may finally get his wish is right down the street. Island, one of the two biggest alternative trading systems and the first one to apply to become a self-regulating exchange, is based just steps from the Big Board, at 50 Broad Street. Island alone now accounts for about 12 percent of the trades each day on the NASDAQ.
Matthew Andresen, Island’s 29-year-old president, works out of a dingy office on the fifth floor with three dusty chairs and a stained carpet in its narrow lobby. At 5:15 P.M., when Island’s online market closes, he jumps up to show me where it all happens – the stock exchange of the future. He leads me down an elevator to the lobby and through the back stairs to the building’s basement. “Do you have the gun?” he asks the security guard, a former New York City cop, who dutifully empties an old revolver for Andresen to play with. “I was stunned when I learned he was packing,” Andresen says, handing it back.
Walking and talking at a frantic pace, Andresen leads me past a small pantry of computers through a locked door into an off-white air-conditioned room full of rows of PCs on shelves. There it is in the back of the room: Island’s candidate to replace the Big Board’s 1,366 floor brokers is a real black box, about the size of a file cabinet. It was purchased off the shelf from Dell Computers for $5,000. (The software inside is proprietary.) Inside, nearly a million orders meet each day to execute 380,000 trades accounting for about 120 million shares. Island feeds the net results into the NASDAQ’s national system. (Today, Island is open from 8 a.m. to 8 p.m., and it plans soon to stay open from midnight to 10 p.m.)
Andresen wears a scruffy goatee and shaves his balding head. He has a broad athletic frame developed as a member of the U.S. national fencing team. After graduating from Duke, he came to New York to train for the Olympics at the New York Athletic Club. All the other fencers worked on Wall Street, so he became interested in doing the same. “Disgusted” by his failure to make the Olympic team, he found a job on the commodities-trading desk at Lehman Brothers, where he fetched coffee and sometimes stapled. He quit in frustration to become a day trader at an office run by Datek Online. “I did all right – I got this job, didn’t I?” he says. “I didn’t like it as much as I thought I would. Day trading was pretty brutal to me, but I got a firsthand look at the market.” He began talking about how the markets might be more efficient with Josh Levine, who was then a young software consultant to Datek. At the beginning of 1998, Levine hired Andresen to manage his start-up electronic trading firm, Island. Datek, which has had its share of run-ins with securities regulators, now owns 73 percent of the company.
The possibility of wholly electronic stock exchanges arrived in the U.S. on January 20, 1997 – a day Andresen calls “the most fundamental sea change in the history of the buying and selling of stocks.” That day, securities laws drafted after a price-fixing scandal on the NASDAQ market created the opportunity for new wholly electronic systems to trade stocks and automatically plug into the NASDAQ network. The NYSE’s rules restrict Island from trading NYSE stocks, so Island applied to become a self-regulating exchange on June 28, and if it succeeds, it will be able to trade Big Board stocks too.
“You are talking to the A-1, true believer,” Andresen says. “It is not just that we don’t have any people and so we are much cheaper – it’s better. When there were 24 guys under the buttonwood tree down the street, they had to do it face-to-face because they didn’t have the technology. It was, ‘Bob, you got any Confederate slave holdings?’ But today it is still people talking to people, and that is inherently inefficient. Maybe Bob had a fight with Steve over the bar tab the night before, maybe Bill went to school with Jim, maybe Estelle is too short and no one can hear her – whatever. It is inefficient; you are making decisions based on something other than the value of the order and when it came in.”
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.