Telephone Access Ruling Fuels NYSE Turf War

The Securities and Exchange Commission's ruling giving investors direct telephone access to the New York Stock Exchange floor is sure to inflame competition between $2 brokers and upstairs trading desks. Since the May 6th decision allowing floor brokers to communicate directly with non-member firms by phone, 59 have received the go-ahead to install outside lines.

By giving $2 brokers the right to accept orders directly from non-member firms, the SEC has opened a new pipeline for investors' orders to reach the floor. It has also initiated a contest between the upstairs trading desks of the large firms and the $2 brokers.

Despite the disparity between the typical commission of a $2 broker ($.75-$1/100 shares) and that of the upstairs trading desks ($4-$12/100), there's been little competition for institutional business. The $2 brokers have traditionally handled the overflow from the upstairs trading operations.

Why? "The exchange had the whole floor sandbagged into believing that it was against the rules to contact outside customers," says William Higgins, the $2 broker who has carried on a six-year crusade for telephone access.

To communicate with customers from the floor, Higgins uses a souped-up Motorola MX Radio with a hip dialer and headset. The device was modified by Buttonwood Communications Inc., of which he's part owner.

His partner and technical advisor is an ex-Pentagon telecom specialist who's devised an unorthodox modulation system that can use all 230 channels in the UHF business band within the confines of the exchange floor. Intermodulation would make a similar concentration of conventional mobile telephones ineffective. Buttonwood has patented its system and stands to profit should portable phones be approved.

Giving institutions access to $2 brokers will "most definitely" result in discounting commissions, says Bob McCann, director of block trading at Merrill Lynch. "The fast-money institutions -- they know who they are -- are going to love it," says a senior trader on Bear Stearns's block trading desk. However, he says, "there won't be a price war. We just won't do it any cheaper than we're doing it now."

But Higgins insists it was never his intention to discount. His prices for "taking the client out onto the floor" will be comparable to those charged by the upstairs desks, he says.

Nonetheless, two of the largest exchange clearing firms -- Wagner Stott, a Merrill Lynch subsidiary, and Spear, Leeds & Kellogg -- are maneuvering to win a share of the $2 brokers' new business.

After the SEC issued its access ruling, the NYSE got a temporary stay. That expired June 10th. The following day, the NYSE filed a proposed rule change at the SEC that would prohibit portable phones.

The NYSE admits that telephone access may enable floor brokers to "compete more effectively for order flow than has heretofore been possible." But the Big Board maintains that direct access to the point of trade -- which would be provided to non-members by mobile telephones -- is a privilege that should be reserved for member firms.

While the filing discusses unequal access among non- members, it fails to address the issue of how portable telephones might give member firms competitive advantage over each other. Allowing floor brokers to use portable phones would enhance their ability to compete for institutional business. Unlike the block trader, the $2 broker can't communicate both with his customer and with a specialist at the same time.

In addition, mobile communications could help small member firms whose booths aren't near the posts where the most active issues are traded. A strategic position on the floor lets a firm's clerk save time by communicating directly to a trader standing at a specialist's post.

Close-in booth locations are much desired by NYSE members. Since the exchange assigns booths based on order volume, Merrill Lynch is essentially guaranteed a ringside seat while a small firm might be relegated to Outer Mongolia.

The NYSE argues that portable phones will put individuals at a disadvantage to institutional customers. "Should access be provided," it says, "the largest, most active customers, probably institutions rather than individuals for the most part, would be offered the advantage. Under these circumstances, the basic integrity of the exchange might seem eroded."

Richard Bernard, a partner at Milbank, Tweed, Hadley & McCloy, fervently champions the cause of the individual in the NYSE's proposed rule change. "This reaction could further discourage investors, especially small investors, from investing in Exchange listed securities. Any such result would be most unfortunate," says the filing (omitting any note of the effect of the insider trading scandal on public trust).

But it's questionable how individual investors -- who are accustomed to calling brokers to place an order -- would suffer if institutions could communicate with a $2 broker standing at a specialist's post. The advantages gained by direct access are likely to be of consequence only to customers placing frequent orders for trades of large blocks.

Another issue raised by the NYSE in defense of its proposed rule is the potential for abuse of mobile phones. Officials paint a scenario in which a portable phone is used to maintain a link between a post on the NYSE floor and another exchange where options on the stock are traded.

Asked if the abuse of portable telephones poses a danger to the integrity of the exchange, Merrill Lynch's McCann says: "The danger is a business danger. The $2 brokers offer direct access to the floor."

Despite its illegality, a more problematic source of portable phone abuse may be electronic eavesdropping. A concentration of static portable phones is a sitting duck for anyone willing to invest a couple of hundred dollars in a scanner, says Robert Corn, a communications lawyer at the Washington, D.C. firm of Hogan & Hartson.