November 27, 2011 / 9:04 PM / in 7 years

Analysis: NYSE stokes Wall St battle for "mom and pop" investors

NEW YORK (Reuters) - The fight for mom and pop’s stock orders is getting testy on Wall Street.

The New York Stock Exchange wants to give retail investors fractions of a penny in better prices when they trade securities listed there.

The plan, unveiled last month, would effectively set individuals apart from funds, brokers and other professionals - who would still pay the publicly displayed prices.

It is an effort to induce retail investors back from trading mostly off-exchange at electronic “wholesalers.” And it means the Big Board is effectively taking on the handful of these wholesale market makers, such as Knight Capital Group Inc and hedge fund Citadel, that have been able to get a first look at retail orders and the opportunity to use that information to aid their own trading strategies.

If the NYSE wins regulatory approval for the plan, it could change the way many orders circulate, and it could mean slightly cheaper trading for Main Street investors.

But that approval isn’t certain given the plan will resurrect a fierce philosophical debate over preferential treatment for some market participants. The U.S. Securities and Exchange Commission has only weeks to decide what to do.

“For the first time in a very broad stroke they could approve the ability of exchanges to discriminate by customer,” said Christopher Nagy, managing director of order strategy at TD Ameritrade Holding Corp, the largest U.S. retail brokerage.

In a way, much of the commotion is because mom and pop aren’t the savviest of stock traders.

Many casual traders don’t even know that their orders rarely end up at the Big Board or Nasdaq. Instead, TD Ameritrade, E*Trade Financial Corp and other online brokers send the orders - up to 12 percent of all U.S. equity trading, according to Rosenblatt Securities — to the wholesale market makers, who fill the orders and pay the broker a small fee for the privilege.

The wholesalers are willing to pay the small fee because mom and pop orders are seen as uninformed - or “dumb”, to use the derogatory industry term. Unlike professional investors with sophisticated short-term strategies and quantitative market analysis, retail investors aren’t usually in a position to keep on top of news, rumors or the flow of orders and liquidity, and may sometimes buy or sell based on a hunch.

The diversion of these orders to wholesalers is quite legal, and said to give retail investors about a tenth of a penny in better prices, on average, than they would otherwise get on the exchanges. It is also one of the main reasons more than 30 percent of U.S. equity trading takes place off-exchange in the anonymous “dark”, up from about 20 percent in 2007.

The payment-for-order-flow by wholesalers and online brokers has frustrated NYSE Euronext and Nasdaq OMX Group Inc, which have seen their market share dwindle over the past decade. NYSE Euronext now has only 35 percent of trading in NYSE-listed stocks, down from 80 percent in 2005.

The SEC, meanwhile, has been increasingly uncomfortable with the growing share of dark trading as it is more difficult to regulate.

“The vast majority of retail traders don’t know that when they’re trading NYSE stocks, they’re not actually trading at the NYSE,” said market structure author and expert Larry Harris, a finance professor at University of Southern California’s Marshall School of Business.

“The NYSE’s proposal is designed to try to recapture some of that retail order flow.”


The NYSE plan, which is called the Retail Liquidity Program, was proposed last month after consultation with the SEC. It is the latest in a long line of attempts by U.S. exchanges to win back retail investors.

If exchanges can attract more “dumb” orders to their market, they’ll also attract more institutions and high-frequency trading firms eager to trade against those orders - which is potentially lucrative trading volume.

But getting the green light will take work.

There is some tough opposition to NYSE’s plan, interviews with wholesale groups and other industry players shows. Overall, though, there is an expectation the SEC will approve an adjusted version of the plan that would give retail investors some sort of exemption for better exchange pricing.

Nasdaq as well as Direct Edge, a private exchange operator that handles 10 percent of U.S. equity trading, are expected to propose similar retail-pricing proposals, according to industry sources familiar with the plans. BATS, another private exchange, is expected to criticize parts of NYSE’s plan, said the sources, who requested anonymity.

The three exchanges declined to comment. The SEC declined an interview, citing the ongoing public comment period.

A raft of letters reacting to the NYSE is expected from brokerages, exchanges and others before the November 30 public comment deadline. The SEC, under Chairman Mary Schapiro, then has until December 16 to decide whether to back the plan or take more time to mull it over, based on the comments.

“I would be quite surprised if the SEC were to approve this as is,” said Jamie Selway, managing director and head of liquidity management at Investment Technology Group Inc. “People have played footsie with this issue of price discrimination ... but this would be a big step for the SEC.”

In detail, here is what the NYSE wants to do:

For a one-year pilot, NYSE would create two new classes of market participants: companies such as E*Trade, Charles Schwab Corp or even wholesale firms that are qualified to send bona fide retail orders to the exchange; the second is market makers that are required to provide “potential price improvement” to the orders in an anonymous, or dark, fashion.

Retail investors would get at least a tenth of a penny in better prices than the best displayed bid or offer at that moment. The NYSE has not yet said how much it will rebate brokers that send the orders, nor how much it will charge firms that provide the liquidity.

It all adds up to a challenge to Knight, Citadel, UBS AG, Citigroup Inc and E*Trade’s market making arm, which are the dominant U.S. retail wholesalers. It could also hurt “dark pool” venues, some run by banks such as Credit Suisse Group AG, where stocks are traded anonymously.


The NYSE proposal effectively gives some people in the market preferential treatment over others. This is not allowed at exchanges, though some argue that wholesalers and those running dark pools already offer it.

Exchange rules are “not designed to permit unfair discrimination between customers, issuers, brokers, or dealers...” the U.S. Securities Exchange Act says.

“My broader concern,” said one brokerage official, “is that the fair access provisions that the exchanges have to abide by are significantly weakened by this.”

Joseph Mecane, NYSE Euronext’s co-head of U.S. listings and cash execution, acknowledged he is challenging fair access provisions, but only to an extent. “What we’re essentially arguing is, by making this program only available to retail customers, we’re not unreasonably discriminating against any class,” he said.

The SEC would also have to grant the NYSE an exemption to a rule that limits the pricing of stocks to no finer than penny increments — that is, General Electric Co’s shares can only trade hands at $15.08, not $15.085 or $15.0852.

In the end, the regulator will have to decide whether NYSE’s plan will bring enough benefit to individual traders and to the public markets to outweigh all the concerns over fairness, and the complaints that it will only complicate an already complicated marketplace.

Reporting by Jonathan Spicer. Editing by Martin Howell

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