Big Board Blues : Many Analysts Question the NYSE’s Future as the World’s Largest Exchange Turns 200
The New York Stock Exchange has whipped up months of hoopla to publicize its bicentennial this year, with celebrations befitting this milestone for America’s preeminent symbol of capitalism.
As the actual May 17 anniversary approaches, exchange officials have planned parties, press conferences, a street festival and publication of a historic book. The U.S. Postal Service is chiming in with a commemorative postage stamp. Workers have trained spotlights on the NYSE’s neoclassical white marble facade at the corner of Broad and Wall to give a new glow to what exchange officials claim is “the centerpiece of a global securities market.”
But behind the noise and lights may be a gathering sense of desperation.
Many securities experts are questioning whether the exchange, though still the world’s biggest capital market, may be slowly losing its franchise. And increasingly brash competitors are proclaiming the Big Board’s old-fashioned trading floor a dinosaur in an era of computerized global trading.
In 1991, as small- and medium-size stocks returned to favor, NASDAQ’s composite index soared 56.8%, nearly triple the blue chip Dow Jones industrial average gain of 20.3% and more than double the gain of the New York Stock Exchange composite index.
NASDAQ, which traditionally has served as an incubator for small companies before losing them to the major exchanges, remains the home of such huge, leading-edge technology concerns as MCI, Apple Computer and Microsoft, much to the chagrin of Big Board officials.
“I guess you’d expect companies like Apple, MCI and Microsoft to be comfortable with state-of-the-art trading technology,” said NASDAQ’s spokesman, Robert Ferri, who notes that NASDAQ is only 10% of the New York exchange’s age but had 90% of its share volume last year.
The New York exchange is also losing market share in NYSE-listed stocks, both to regional exchanges and to NASDAQ. Its share of consolidated tape trades of NYSE-listed stocks fell to 67% last year from 85% in 1990; meanwhile, NASDAQ’s share of the business jumped from less than 1% to nearly 10%.
The Big Board held up better in consolidated volume, which it contends is a better measure, where it maintained a nearly 83% share in 1991. Still, NASDAQ managed to do nearly 5% of the volume in NYSE-traded stocks. An undetermined amount of trading--perhaps equal to 10% of the Big Board’s volume--is also taking place offshore, principally in London.
Little wonder, then, that while the New York Stock Exchange is touting its own 200th birthday, the 20-year-old NASDAQ is brashly promoting itself as “the stock market for the next hundred years.”
While markets around the globe reject the NYSE’s trading floor-based “auction” model and embrace computerized “screen-based” dealer trading systems, the Big Board clings to its old way of doing business in part due to the influence of such special interests as its specialist firms.
“Every exchange that has seriously studied the question--London, Paris, Frankfurt, Tokyo-- . . . (is) moving toward screen-based systems,” said Bernard L. Madoff, chairman of a New York-based brokerage firm that bears his name and that is a thorn in the New York Stock Exchange’s side.
Adds Ferri: “If you were to design a stock market in this era of computers and communications, you certainly wouldn’t have all these people milling around with little pieces of paper.”
Big Board officials say they are fully aware of the erosion in market share. “We’re not going to sit back and let that continue,” says William H. Donaldson, who as chairman and chief executive officer is charged with reversing the Big Board’s decline. “We’re going to take our gloves off.”
“The challenge for the NYSE is the challenge of renewal,” adds Richard Grasso, the NYSE’s executive vice chairman, president and chief operating officer.
Besides, he argues, the Big Board’s market share, measured in volume, is none too shabby. “What are the odds of a business being around for 200 years, going through an absolute revolution in technology, regulation and pricing, and still maintaining an 83% market share” of trading in Big Board-listed stocks? Grasso asks.
Donaldson dismisses criticisms that he has moved slowly in his first year at the helm of the Big Board. “I basically believe in coming in and learning what’s going on before making the changes necessary to build for the long haul.”
And he insists that the past placid year is not a prologue for his reign. “I don’t want to scare everybody,” the gentlemanly chairman says, “but I hope you’ll see a lot of changes here.”
Donaldson’s first and only major appointee--former Los Angeles Times Assistant Managing Editor John Lawrence, named vice president for communications--is mapping a new communications strategy, including TV ads, and pushing the exchange to be far more open to press inquiries.
The Big Board’s fundamental message is simple: A traditional “auction-style market” in which buyers and sellers come together on the exchange floor is inherently fairer to investors than a dealer-dominated computerized “screen-based” system such as NASDAQ.
“A dealer market is inherently less efficient and cost effective,” Donaldson says. “The dealer is in on every transaction. When you buy, you’ve got to buy from a dealer, and when you sell, you’ve got to sell to a dealer.”
On the Big Board, by contrast, he says, “in 90% of transactions, a natural buyer meets a natural seller, with no middle man taking a spread.”
Not everyone agrees. Bernard L. Madoff Investment Securities has developed a proprietary, state-of-the-art automated trading system that allows Big Board members to bypass the exchange floor. He contends that “if the NYSE disappeared tomorrow, the world would go on.”
To the casual observer, Madoff’s modern-art filled mid-town Manhattan operation appears as streamlined and efficient as the Big Board’s cavernous gilded trading hall seems unwieldy. Fifty traders, backed up by 50 computer systems people behind the scenes, sit at their computer terminals, quietly monitoring transactions.
Ninety percent of Madoff’s transactions are handled computer-to-computer; execution time is a brisk five seconds. On some days, Madoff’s tiny operation handles 10% of the transactions in Big Board stocks and 5% of total volume, and Madoff claims that his system has the capacity to do twice that much.
Despite a barrage of criticism aimed his way by specialists and exchange officials, Madoff, whose firm pays a penny a share for orders, says: “If we weren’t doing the best for our customers, we wouldn’t be getting that order flow.” Madoff makes his money on the spread--typically 12.5 cents a share, between the buying and selling price.
“There is no reason, with computers being the way they are, with communications being the way they are, that all orders (for NYSE-listed stocks) should automatically flow to the NYSE,” Madoff adds.
He rejects assertions by NYSE specialists and members that he is merely “piggybacking” on the Big Board’s price discovery mechanism, or that he is involved in predatory pricing. “I spend a lot of time defending myself, unnecessarily,” he says. “The NYSE should spend as much time improving their own systems and quality of markets as they do giving out misinformation about their competitors.”
The Big Board has taken a number of steps to meet the competition, including the inauguration of a special after-hours “crossing session” that allows buyers to meet sellers at a given stock’s closing price.
But in the fight to remain competitive there are signs that the Big Board’s clout is waning within the securities industry. In a major embarrassment, the Big Board’s plan last summer to open the market half an hour earlier, at 9 a.m. Eastern time--resulted in a humiliating about-face.
Donaldson and his board of directors announced the change after consulting chief executives of member firms accounting for 55% of the Big Board’s business. “Most everybody at the CEO level said, ‘Go for it,’ ” he recalls.
What he hadn’t recognized was that the exchange’s members “speak with many voices.” The rank and file were outraged at the prospect of starting work half an hour early, especially on the West Coast, where the time difference means the trading day starts three hours earlier. When San Francisco-based Montgomery Securities began a petition drive to fix the opening time at 9:30 a.m. Eastern time, the firm won wide support.
Still, Donaldson believes that the Big Board will eventually be forced by competitive pressures to expand trading hours to compete with overseas markets. “I believe very firmly, as we become a world exchange, that we’re going to have to adjust our hours,” he says.
Donaldson’s part in the fiasco represented a curious role reversal for the one-time rebel against Big Board rules and regulations. In 1969, as a founder of the investment firm Donaldson, Lufkin & Jenrette, Donaldson was in the spoiler’s role when the Big Board refused to allow his firm to offer shares to the public.
A long public battle ensued before DLJ finally won the right to go public, and now most of the Big Board’s giants are publicly traded companies. Today’s NYSE, the patrician chairman stresses, “is a vastly changed organization” from the exchange that originally opposed DLJ’s plan to go public.
“Having said that, I expect change in the future to come at an even more rapid pace,” Donaldson says.
Still, there are those who question whether Donaldson has the gumption to go up against the NYSE’s venerable specialist system. Specialists, who are charged with maintaining orderly markets, must commit their own capital and be buyers when everyone else is selling and be sellers when everyone wants to buy.
“Three hundred and sixty four days a year, being a specialist is like having a license to steal,” says John Keefe, a brokerage industry analyst with Lipper Analytical Securities Inc. “I compare them to toll collectors, picking up nickels and dimes. They see a lot of trades, and if they skim a little here, a little there, they make a lot of money that way.
“It would be far more efficient and effective for computers to do the drudge work--the simple comparison,” he adds.
The specialists do not see it that way. “The New York Stock Exchange will never be the lowest cost provider of trading services--never,” says specialist Robert W. Seijas. “But cheaper isn’t necessarily better for the customer.”
More ominously, he adds, if liquidity on the Big Board dries up, “you dry up the pricing mechanism, to everyone’s detriment, and the whole market suffers.”
Finally, Seijas says, “in crises, dealers can just duck. They don’t pick up the phone, or say ‘not today.’ ” With the specialist system, “the specialist has an affirmative obligation to buy, with leaning against the wind.”
The Big Board also provides better regulatory mechanisms, its partisans add, because it is inherently easier to keep tabs on a centralized marketplace.
Still, Donaldson understands that in the war of images, the Big Board will always be at a disadvantage.
Despite widespread automation of Big Board operations, “the visual image of the floor of the stock exchange that is projected nightly on television--a lot of people running around--is out of the 19th Century.”
The NYSE Handles Fewer Trades...But Still Controls Most of the Volume
NYSE’s share of individual trades of Big Board-listed issues:
1980: 85.4%
1991: 67.3%
NYSE’s share of total trading volume:
1980: 87.8%
1991: 82.3%
Source: New York Stock Exchange
