http://www.nytimes.com/library/financial/092499market-sec.html September 23, 1999
S.E.C. Chief Wants One Site for Posting Stock Prices
By GRETCHEN MORGENSON he chairman of the Securities and Exchange Commission proposed a system Thursday for displaying electronically all orders to buy and sell United States stocks and called such a central posting essential to preserve the integrity of the nation's stock markets.
Arthur Levitt, the S.E.C. chairman, outlined his general vision for the financial markets yesterday after months of wrenching changes in how stocks are traded. New electronic trading systems have emerged, on-line trading by individuals has exploded, trading by small investors has begun to occur outside the exchanges' hours of operation and the exchanges themselves have proposed becoming publicly traded for-profit companies.
A FINANCIAL REVOLUTION
Levitt seems most concerned that if trading continues to migrate to the new electronic market systems, investors may not get the best prices. Information about orders and transactions across the entire market are not now available in any one place. Technology, he said, allows the creation of a central system in which investors will be fully informed about prices everywhere, from the New York Stock Exchange, the Nasdaq market, the American Stock Exchange and the new systems.
He stressed that he was asking for the development of a technology that would allow all orders to be shown to investors, not an institution or a place where all orders would be executed. In this way, competition would continue, along with innovation and pressure to keep costs low. "The beauty of this is technology has taken us to the point where we may be able to enjoy the benefits of competition while getting the benefits of centrality," Mr. Levitt said.
Speaking at Columbia Law School, Levitt also said he was intrigued by the possibility of creating a single, self-regulatory organization to oversee the markets but suggested that each exchange continue its own surveillance. The exchanges now have self-regulating units, but those units could be compromised or at least conflicted if the exchanges become public companies with an obligation to provide the highest return to shareholders.
In other areas, he was most concerned about fairness. He urged the elimination of a rule by the New York Stock Exchange that prohibits the trading of certain stocks by exchange members anywhere other than on the exchange floor. Fees charged to outside participants by the new electronic stock networks, he said, should also be eliminated. And the options exchanges, which have been effective monopolies for decades, must open their doors to true competition, he said.
"I recognize the industry's inherent resistance to change," Levitt said in an interview before the speech.
"But I'm willing to fight very hard to move in the direction of change rather than being a custodian."
Frank Zarb, the chairman of the National Association of Securities Dealers, the parent of the Nasdaq market, applauded Mr. Levitt.
"I think he's saying to us, 'You guys get this stuff fixed or we're going to have to see that it gets fixed,' " Mr. Zarb said. "It's a good clear menu of the major issues facing the industry -- a call for bold change when bold change is required."
Levitt said his ideas were the result of yearlong deliberations with the S.E.C. staff and conversations with market participants. The proposals will result in stock markets that are more open, accessible and fair to all investors, he said.
But given that so much about Wall Street remains hidebound even as great change has rocked the industry, the proposals will displease many in the business, both new and established. The organization that appears to have the most to lose under the proposals is the New York Stock Exchange, though its chairman said yesterday that the exchange was prepared to reinvent itself with the times.
Levitt, 68, who has been the nation's chief securities regulator since 1993, this month became the longest-serving chairman in the commission's history. With the speech, he sought to position himself as the chairman who seized technological advancements as a way to level the playing field for investors and market participants of all types.
Levitt couched his speech by asking many questions. This will surely disappoint market players who were looking for answers from the nation's top regulator and a clearer regulatory blueprint, though initial reaction yesterday was strongly positive to the speech.
Jack Brennan, chief executive of the Vanguard Group, the mutual fund giant, said, "While innovation is a great thing, you always want to know that the innovation taking place is happening with integrity."
Levitt made clear that he was not giving the securities industry its marching orders. Rather he was trying to shape the dialogue that must occur before changes can be made. "I want to see the natural genius of the marketplace give vent to a better, cheaper, more protected market," he said.
Because commission approval is necessary for market participants who want to expand their businesses, however, Levitt's opinion is critical for firms and exchanges that want to move quickly to form alliances, make deals or extend their hours without losing business to more nimble competitors.
The stock markets are undergoing rapid change and appear on the verge of even more competition, with demand growing for instant access.
While innovations like new electronic markets, extended trading hours and on-line trading have helped drive some investors' costs down, there is a potential downside. Individuals buying and selling stocks may not be getting the best prices on their trades because the various marketplaces are not connected. In some cases, an order placed in one venue may be completed there even though a better price may be available elsewhere.
And though some electronic networks already offer trading into the evening, there are relatively few orders, meaning investors cannot be assured of getting as good of a price as they would in a bigger pool of orders.
With his proposal for a centralized system for stock market information, Levitt is treading on turf explored by another S.E.C. chairman, Harold M. Williams, in the late 1970's. Back then, the commission set out to help the securities industry create a national market system through a central book of orders to buy and sell stocks. But the powerful Wall Street brokerage firms and exchanges blocked the plan and it quietly died.
Luckily for Levitt, Wall Street may not be as opposed to the proposal this time around. One reason is that technology has advanced sufficiently since the 1970's that such a system could easily be created. Moreover, many of the established brokerage firms own parts of the new trading networks, giving them a foot in both the old and new camps.
Bernard L. Madoff, principal of Bernard L. Madoff Investment Securities, a market-making firm that stands to lose from one of Mr. Levitt's proposals, sounded sanguine yesterday. "A central limit-order book -- that's something we have to see more of what it would look like," he said. "It's been something that has been talked about for a very long time. It's been difficult to achieve because of turf wars but probably if it ever has a chance of happening it would have a better chance today."
Zarb of the N.A.S.D. said his organization would soon be filing with regulators its plans for a central order book that has many of the characteristics described by Mr. Levitt. "What we're going to be filing with the S.E.C. this week or next has all the tools," Zarb said. Previous efforts to create such a book failed to win broad member support, because some big dealers worried that by running such a centralized order book, the N.A.S.D. would be competing with them.
Levitt's idea for a single self-regulatory organization to police the investment arena is not exactly new. What was new in his speech was his suggestion that the crucial duty of market surveillance would remain local and performed at each exchange, close to the operations. The S.E.C. chairman said that plans by both the N.Y.S.E. and the Nasdaq to issue shares in their organizations to the public could not be pursued until well-researched plans for spinning off both exchanges' regulatory arms were provided to the commission. "We must be certain that their plan to create a separation is sufficiently definite," Levitt said in an interview Thursday. "There can be no backing away from it. There won't be any game playing."
Some market experts had hoped that a single independent regulator would be a condition of any conversion by the exchanges to public companies, but Levitt stopped short of insisting on that.
Even the tradition-bound New York Stock Exchange took Levitt's calls for change in stride. A central order book appears to be a problem for the exchange since it would include those stocks whose executions are now handled exclusively by specialists on its floor. Levitt's call for the elimination of a rule by the exchange that bars members from trading listed shares off the floor, known as Rule 390, would bring more competition for the exchange's specialists as well.
Nevertheless, Richard A. Grasso, chairman of the exchange, said his organization was up to the challenge. "Change driven by customer patterns and by technological advancement necessitates reinvention," he said in an interview. "Those that reinvent themselves will succeed beyond their wildest expectations. We have always been successful at reinventing ourselves."
The S.E.C. chairman expressed interest in opening options trading to increased competition as well. The established exchanges, including the Chicago Board Options Exchange and the American Stock Exchange, have had a virtual monopoly on the options they traded. Under a gentleman's agreement, they did not trade each other's offerings. But they are now beginning to trade each other's options and feeling the heat from an electronic trading system, the International Securities Exchange in New York, which expects to begin trading options in March.
Levitt pointed out that the prospect of a new entrant has fostered some nascent competition among the established options exchanges. The S.E.C. studied four actively traded options and found that competition has reduced the effective costs of buying and selling them by 22 percent to 44 percent.
Interestingly, the new electronic communication networks, such as the Island E.C.N., that have brought much of the recent upheaval to Wall Street also stand to lose if Mr. Levitt succeeds in eliminating the fees they charge.
Douglas M. Atkin, chief executive of Instinet, the oldest, most established electronic trading network, was enthusiastic about Mr. Levitt's ideas, even though his company reaps E.C.N. fees. "If you get to an efficient market structure, a pure central limit order book," Mr. Atkin said, "then there's no need for E.C.N. fees." Presumably, the E.C.N.'s would get more business if quotes were more widely disseminated and could alter their business model in other ways to remain profitable.
The electronic networks, however, will benefit from other ideas floated by the S.E.C. chairman, such as the creation of a centralized order book and the elimination of the rule restricting trading in certain N.Y.S.E. stocks.
Harold S. Bradley, senior vice president and portfolio manager at American Century Investment Management in Kansas City, said he was struck by how open the commission seemed to the young firms. "It's mind-blowing how realistic their thinking is about the evolution and change in the marketplace," he said. "This is an exciting and visionary statement from an agency that has traditionally protected the monopoly players."