Move Over, NYSE? OptiMark System Creating a Buzz

Twenty-three years ago, Congress ordered the U.S. securities industry to move toward a “national market system”--a unified market in which competition would generate the best prices for stocks, market information would be readily available to all investors and securities dealers would always place the interests of their customers first.

Are we there yet? Bill Lupien is betting $110 million of his and other people’s money that we aren’t there--but that he holds the key to finally creating the fair, open and efficient national market system that Congress wanted.

Lupien’s new OptiMark Technologies Inc. trading system is generating a major buzz on Wall Street. Operated by a supercomputer, OptiMark promises to continuously take in buy and sell orders for stocks from both institutional and individual investors, match them instantaneously at the investors’ preferred prices and execute the trades--all in total secrecy, except for reporting each transaction to the market once completed, for all to see the price and size of the trade.

The Pacific Exchange (formerly the Pacific Stock Exchange) was the first to decide to tie itself to OptiMark. The Nasdaq Stock Market and the Chicago Board Options Exchange also now are on board, and IBM Corp. and Dow Jones & Co. have signed on as strategic partners.

Most important, Lupien says he has so far persuaded more than half of the 220 largest U.S. institutional investors, plus 60 broker-dealers, to give his system a try when it is launched, tentatively around Labor Day.

Yet OptiMark’s success is far from assured. Many big investors, although intrigued byOptiMark’s possibilities, wonder if it can deliver. “This is either going to be the greatest thing since cracked nuts, or the next Edsel,” said one institutional investor, mixing his metaphors but making the same basic point expressed by others.

For small investors, who have watched the Nasdaq Stock Market finally be beaten into submission over the last year (23 years late, by Congress’ watch) in terms of giving individuals a fairer shot at better stock prices, OptiMark’s development is worth watching at least.

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What does OptiMark offer that current trading systems don’t? Computers, after all, now facilitate most market systems; that’s how we’ve come to trade upward of 500 million shares daily on both the New York Stock Exchange and Nasdaq--numbers that seemed too large even to contemplate in the early 1970s.

Lupien’s novel idea, developed with a rocket-scientist-type named Terry Rickard, is to give a supercomputer near total control of the process of trading, but only after investors have entered buy or sell orders that specifically instruct the computer where the investors’ optimal trades would be.

Whereas modern (and reviled) “program” trading automatically triggers buy or sell orders based solely on market swings, the OptiMark system seeks to match buyers and sellers if they can be matched.

Today, that job of putting buyers and sellers together is performed by the stock exchange’s individual “specialists” (on the exchange floors), by broker-dealers (in the Nasdaq market) or by automated systems such as Instinet that allow big investors to trade among themselves in large blocks of stock.

But Lupien, who was a Pacific Exchange specialist from 1965 to 1982, then Instinet’s CEO from 1983-88, contends that all of those systems have drawbacks that keep them from delivering the best possible national market to investors.

OptiMark, he said, “is a change in the concept” of trading--maybe the biggest change in 200 years, his marketing people suggest, with typical marketing chutzpah.

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Here’s how OptiMark works: The system’s supercomputer operates during normal trading hours, during which time institutional investors can send their buy and sell orders directly to the system, rather than to the NYSE, Nasdaq or other markets.

The key to the OptiMark system is that investors aren’t limited to indicating a single price for a single block of stock either to buy or sell. Instead, an investor can design a changeable “profile” for each stock, indicating willingness to trade specific volumes at specific prices--for example, no shares at $51.50, 10,000 shares at $51, 20,000 at $50.50 and 30,000 at $50.

Most significant, those profiles are known only to the investor entering them and to the OptiMark supercomputer. No one can see into the system, including OptiMark’s own people. (Accounting firm Deloitte & Touche has been hired to certify the system’s security.)

Those guarantees of investor anonymity and nondisclosure of order sizes (except within the market itself) are two of OptiMark’s principal drawing cards. Why? Put yourself in the place of a mutual fund manager who on any given day may be buying tens of thousands of shares or selling tens of thousands of shares, or both.

If you enter an order into the market to buy 50,000 shares of XYZ Corp., you are immediately showing your hand to others in the market. What happens then? Other investors, and dealers, may push up the price of the stock for no other reason except that they know you are interested in buying.

That “market impact” effect of your order may not be significant if the stock is a highly liquid issue such as IBM. But for the majority of stocks--most issues, after all, aren’t big stocks--market impact is a major risk for large investors.

Various studies have estimated that market impact in trading can cost big investors as much as 10 times whatever they’re shelling out in commissions for a given trade.

Trading within the OptiMark system is supposed to eliminate the market-impact problem because only the supercomputer knows what kind of orders are in the market, and its only job is to match those orders according to the profiles investors enter. To put it another way, the computer’s only job is to try to make everybody as happy as possible, in the context of the prices they’ve indicated they’re willing to pay.

Also, unlike other electronic matching systems that put big investors’ orders together infrequently during the day, OptiMark will run in 90-second cycles. That, Lupien says, will give the computer time to look at all of the entered stock profiles, check other competing markets (such as the NYSE and Nasdaq) for better prices than what the profiles show, and execute trades at the optimal prices available, wherever they are.

Small investors, although unable to enter their own profiles into the OptiMark system, nonetheless can benefit from the system, because it will bunch together smaller orders seeking the same price into single orders large enough to match with institutions’, Lupien said.

That is part of what appealed to the Pacific Exchange when it decided to become OptiMark’s “introducing exchange” for equities, said Pacific Exchange Chairman Robert Greber.

If Congress’ mandate from 1975 is to be taken seriously, then “the ideal is to find a system that lets institutions do what they want and also allows individuals to participate along with them,” Greber said.

It’s important to note that while the sizes and prices of orders in the OptiMark system are cloaked, each final trade is not. All investors will see the results of each OptiMark trade printed on the market “tape,” just as each trade now, wherever it occurs, appears on that tape--which tells the market what’s happening with prices and volume.

Lupien, whose privately held company is based near his ranch in Durango, Colo., says the most important role that OptiMark could play is in increasing overall market liquidity--which then could dampen stocks’ price volatility.

How? Because if large investors know that they won’t be penalized (by triggering sharp price moves) for simply indicating that they’re interested in trading a substantial number of shares, the market at any moment could become much larger and more liquid, he said.

“If it does everything it promises, we’re going to have another system competing [to create] liquidity, and we like that,” said Scott Shellhamer, head of equity trading at the PBHG Funds.

“We’re hopeful that this will develop,” added Gus Sauter, manager of Vanguard Group’s giant Index 500 stock fund.

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Yet even as many institutional investors sign up to trade on OptiMark, skepticism is high. Lupien needs a critical mass of active investors when trading begins, or OptiMark could flop.

Some traders who have seen the system say it’s too complex and that most investors won’t have the time to create and continually tweak their stock profiles. “Too much clicking and dragging” on a computer screen, one trader said.

Others rebut that. “A profile can be as simple or as [complex] as you want to make it,” Shellhamer said.

While Nasdaq has embraced OptiMark, the NYSE has not.

Is OptiMark a competitive threat? Lupien insists that his system is not designed to eat Wall Street as we know it. OptiMark is not a dealer--just a service, charging per-trade fees. Human traders will still be needed to advise investors; broker-dealers and specialists will still be needed to add their capital into the mix, assisting clients in buying or selling.

Still, Lupien admits: “We’ve just bet a hell of a lot of money . . . that this is the only way people are going to want to trade.”

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Tom Petruno can be reached at tom.petruno@latimes.com