Electronic trading: portal to the future? Technological advances are moving markets toward an all-electronic environment, thanks in part to the growth of electronic exchanges. But the specialist system is far from dead, and some experts see a continuing need for at least occasional human intervention.

• Author: Millman, Gregory J.
• Position: Cover Story

Every company has an interest in liquid and efficient capital markets. Some feel so strongly about the issue that they've made dramatic public calls for change in the market structure--even voting with their feet.

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In January, 2004, for example, New York Stock Exchange (NYSE)-listed Cadence Design Systems announced that it was joining the new dual listing program of the Nasdaq Market System. Cadence CFO William Porter explains the company's decision to dual-list as a shot across the bow of an outmoded market structure. "We do support electronic markets, and we think the movement to more electronic markets would be better for all trading. That was one of the reasons for us to try this experiment--to get more of a focus on electronic trading."

Cadence wasn't alone. Five other companies simultaneously announced their decision to dual-list on the Nasdaq in January 2004. A year later, insurance behemoth American International Group (AIG) announced its own dual listing decision--not on the Nasdaq but on the upstart Archipelago Exchange, founded as an electronic communications network (ECN) in 1996. (In addition to AIG, Metropolitian Healthworks, an American Stock Exchange-listed company, and options brokerage optionsExpress, a Nasdaq-listed firm, have dual-listed on Archipelago this year, according to a spokesperson.)

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What's going on here? Of course, you could count on your fingers the number of corporations that have opted to make a statement with their listing decision--and you wouldn't even need all of your fingers to do it. Moreover, the decision to dual-list makes little difference in how stocks trade: It is more of a political statement than a financial tactic.

"Other markets have long traded NYSE stocks, and most of these stocks were already traded on the Nasdaq, so I take the dual listing to be a statement of a degree of dissatisfaction," says Hendrik Bessembinder, Professor of Finance and A. Blaine Huntsman Presidential Chair in Finance at the University of Utah's David Eccles School of Business. "These companies were saying they were not totally satisfied with how things were being handled in New York."

Indeed, Porter says that in the year since the dual listing, he has seen little change in how Cadence's stock trades, but quickly explains that's at least in part because Securities and Exchange (SEC) regulations continue to give the NYSE an advantage in the trading of listed stocks. The "trade-through" rule requires that trades go to the market with the best price, but Porter says that 70 percent of the holders of Cadence stock are institutions.

"They're not as interested in best price as in speed and anonymity of execution," he explains. "But as long as the trade-through rule exists, if you have a large institution wanting to sell 500,000 shares, and Mom & Pop want to trade a hundred shares for a penny better, the whole trade gets kicked over to the specialist."

Every NYSE stock is assigned to a specialist whose job is to ensure an "orderly market," providing liquidity by stepping in where angels fear to tread, buying in falling markets and selling in rising ones. Specialists get compensated with privileged access to information and can step in ahead of other investors to "price improve" bids and offers.

ECNs and electronic exchanges, by contrast, have no specialists. Bids and offers meet directly and automatically. Critics have long charged that the NYSE specialists often are less a help than a hindrance, an unnecessary and costly drag on the market. "I think the specialist system has...