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Two Plus Two Equals What?

In Merger Math, Change for Investors Is the X Factor

By Ben White
Washington Post Staff Writer
Sunday, May 1, 2005; Page F01

Peggy and William Schmeltz haven't stayed up nights pondering the larger meaning of the New York Stock Exchange's decision to merge with electronic trader Archipelago Holdings Inc., or the Nasdaq Stock Market's plan to buy online trader Instinet Group Inc.

But the retired Ohio couple, both active investors, suspect the deals represent a historic shift in the way stocks are bought and sold.

Their gut feeling is that the deals will probably lead to faster, cheaper trading. And that, they say, can't be a bad thing.

"The only thing I'm concerned about is fair trading," said William Schmeltz, a certified public accountant who occasionally trades stocks online through his Fidelity account. "If these deals result in that happening, that's good."

Schmeltz said he once believed that NYSE floor traders provided a valuable public service, keeping markets calm and matching buyers and sellers at the best price for both sides. Now, with 15 former and current traders criminally charged with cheating investors out of the best prices for their trades, he said he thinks they exist mainly to snatch profit for themselves. At his expense.

"I think they try to take a quarter-point here and quarter-point there, whenever they can. So if you can shorten the process and eliminate the people in the middle, that's better," he said.

The Schmeltzes, of course, do not represent the full spectrum of opinion on the two big stock market deals announced earlier this month. The NYSE would become a for-profit, publicly traded company if its deal goes through; Nasdaq wants to do the same.

On one level there is general agreement: If approved, the two mergers will almost certainly create a pair of dominant competitors who will go all out to execute the largest number of trades, at the fastest speed and with the lowest cost. That means they will be aggressively courting big, institutional investors who account for more than three-quarters of daily stock trading volume, according to estimates.

But there is less agreement on whether this will benefit individual investors. Many mutual fund executives say it will by reducing execution costs, with the savings going to fund shareholders. But some consumer advocates, academics and other financial observers wonder whether the brutal competition will lead the markets to scrimp on surveillance duties and rule enforcement while catering to big players at the expense of the little guy.

And some fear that intense pressure to produce results for shareholders will lead a newly public NYSE to finally abandon its system, built around human traders, in favor of an all-electronic market. They say that while that might work well for heavily traded shares, it might be more chaotic for stocks that trade infrequently. Those stocks tend to have bigger "spreads" between the best bid and offer price.

The NYSE is the last big stock exchange in the country to conduct business on a physical trading floor. The exchange already offers some electronic trading but the vast bulk of orders are sent to the floor where traders called specialists match buyers and sellers at the best possible prices for both (or at least that is what they are supposed to do).

Nasdaq is a computerized trading system born in the 1970s as an informal group of broker-dealers, known as market makers, who traded non-NYSE stocks over the phone and via online systems. Over the years, Nasdaq has improved its order-matching system to the point where it now operates more like an electronic communications network, or ECN.

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