• Introduction
• Similarities
• Differences


• Worldwide Securities Industry Trends


• Role of Exchanges
• Execution Services/ Market Access
• Self-Regulatory Services
• Clearing Services


• The Regulatory Climate


• Concerns Regarding ECNs


• NYSE and NASDAQ Responses To ECNs
• NYSE
• NASDAQ/AMEX
• Regulatory Support
• Pacific Stock Exchange


• Conclusions


• Appendix I - Electronic Communications Networks
• Archipelago
• Attain
• B-Trade
• BRUT (The Brass Utility LLC)
• Instinet
• Island
• NexTrade
• REDIBook
• Strike


• Appendix II - Alternative Trading Systems
• Arizona Stock Exchange
• BRASS
• Optimark
• POSIT Crossing Network


• Appendix III - Glossary

The rapid growth and popularity of Alternative Trading Systems (ATS) and Electronic Communications Networks (ECN) is the result of a technology evolution, the increasing willingness of the investment community to trade without brokers and a favorable regulatory climate. As the speed, cost efficiencies and accessibility of electronic trading have become recognized the weaknesses of traditional trading methodologies were obvious, especially as the floor-based exchanges have not kept up with the pace of change.

While institutional traders were the primary market and spurred the initial growth of electronic trading, the burgeoning use of the Internet and the emergence of a brokerless retail market has also been fueling the growth of ATSs and ECNs. The use of these forms of trading by institutional and individual investors increasingly will shape the market and create a climate that is conducive to the universal use of electronic markets. Electronic trading is already taking market share away from the floor-based stock exchanges and NASDAQ, with an estimated 25% of NASDAQ's volume now coming through ECNs.

For some industry observers, the question is not how big electronic markets will become or how much they will dominate the securities market, but when will they become the only way to buy and sell securities. As Gregor Bailar, EVP and chief information officer for the National Association of Securities Dealers and an advocate of electronic markets, said in a speech in New York last May, "We believe ... physical markets are being replaced entirely by the network."

Benn Steil, economist and senior fellow at the Council on Foreign Relations, went even further when he told Reuters, "In virtually every country, the historic regulatory model is based on the notion that there are logical distinctions between the roles of exchange, broker and investor. Technological developments have broken that down entirely."

Whether or not there will continue to be any role for floor-based exchanges is still subject to debate; however, it is clear that their traditional role will never be the same. This White Paper discusses how this situation developed and provides some insight into where electronic trading is headed.

INTRODUCTION

There are several terms that are used in this debate, many of which are often used incorrectly.

An Alternative Trading System (ATS) is an electronic system that can bring together potential buyers and sellers of securities, and which may disintermediate the traditional broker's role in trading. ATSs include call markets, matching systems, crossing networks, and Electronic Communications Networks (ECNs). An ECN is an ATS that has registered with the SEC as either a broker or an exchange.

"ECNs are basically a subset of ATSs," said John Heine, a spokesperson for the Securities and Exchange Commission's market regulation division. "In one sense, they are like ATSs that are required to post their quotes on NASDAQ. ATSs can include a whole range of varyingly structured trading systems. ECNs basically function as a price discovery system."

The similarities and differences between ATSs and ECNs are shown in the following chart. Additional terms are defined in the Glossary at the end of this White Paper.

SIMILARITIES

• Matching
• Electronic Communication
• Post indications and each participant may find a counter party
• Anonymity

DIFFERENCES

• ECNs are registered with the SEC as either a broker or an exchange
• ECNs are regulated by the NASD if they are brokers, and are SROs and regulated by the SEC if they are registered as an exchange
• ATSs can be used by the principals to a trade, but ECNs only act as agents
• ECNs automatically match trades that have been entered as limit orders
• ECNs can be connected to NASDAQ or the floor-based exchanges through the Intermarket Trading system (ITS)
• After an ATS trade has been completed, the brokers send the trade to NSCC for clearing, but the ECN can send the matched trade directly to a clearing agency
• ECNs can trade options and connect to the Options Clearing Corporation

Despite these stated similarities and differences, the exact definitions of ECNs and ATSs are still evolving. There are still some differences of opinion, and areas of confusion. For instance, some of these applications are also called electronic crossing networks, but they are not necessarily the same as the Electronic Communications Networks, although they are both often referred to by their initials - ECN.

According to ITG/POSIT, which is a crossing network that has linked up with Bloomberg's Tradebook ECN, "An Electronic Communication Network is a regulated type of agency broker [i.e., not a dealer or a market maker] that facilitates continuous matching of customer buy and sell orders while providing those orders with direct electronic access to the National Market System [NASDAQ]. A crossing [network] electronically matches buy and sell orders at a derived price."

Rick Roberts of the Electronic Traders Association agreed with that definition but believed it would change. "That's true at the moment, but there are ECNs being developed right now that may not have to comply with this NASDAQ listing requirement."

"The regulatory categories are in flux," said Steve Wunsch, president of the Arizona Stock Exchange, an electronic call market. "We've been called an exchange, a broker / dealer and a sponsored trading system. But we're not an ECN."

A fundamental source of conflict occurs because all ECNs are regulated by the National Association of Securities Dealers (NASD), the NASDAQ's parent organization, and have access to NASDAQ; however, some are electing to become stock markets which are registered with the SEC and which could then also connect to the other US exchanges through the Intermarket Trading system (ITS).

A fundamental change may take place if NASD and the NASDAQ split into separate organizations, which may occur if NASDAQ decides to go public and the NASD remains as a regulating body.

WORLDWIDE SECURITIES INDUSTRY TRENDS

There are six basic trends that affect every participant in the securities industry worldwide:

• Comoditization of the basic securities processing services
• Changes in customer requirements
• Increased settlement efficiency in each country
• Lower margins on the basic services
• Securitization of assets
• Shifting sources of cross-border investment

Many firms are reacting to these basic trends by reevaluating their position and role in the industry. This is causing:

• Shifting alliances in the infrastructure
• Increased competition
• Increasing disintermediation of the traditional players

Finally, as firms develop their on-going strategies, they have to consider two other trends in order to develop their implementation plans:

• Increase in the use of standards
• Availability of new technologies

These trends are creating new opportunities for the securities industry participants and infrastructure, and will also create numerous potential pitfalls. If infrastructure firms fail to adapt to the new realities of the securities business and do not solve their customers' problems, disintermediation will be hastened, not postponed.

Evaluating the impact of these trends results in some specific implications for the overall securities industry.

• Firms will increasingly use technology such as Customer Relationship Management to provide one-to-one marketing, which will use high tech solutions to achieve high touch relationships with clients.
• Markets for different instruments in different regions and countries will become increasingly homogenous, and the retail market will act more and more like the institutional market, with the exception of block trades.
• Despite slow-downs in Asia, crises in Russia and risk in emerging markets, the world economy will continue to move towards deregulation, as capitalism becomes even more pervasive. This will increase competition from traditional as well as non-traditional participants.
• Utilities such as exchanges, depositories and clearing houses will have to compete in order to remain relevant. They will compete with each other, as well as with vendors and non-traditional participants. Trading days will increase in length, decimalization will be in place and shorter settlement cycles will increase the pressure on traders and processing departments.
• Fewer process steps will be required to complete transactions due to automation and a shorter settlement cycle. This will continue the industry's evolution away from clerical staff towards technically proficient people at all levels, who will be in increasingly short supply.
• The traditional processing functions will disappear as the best people are refocused into areas such as risk management, technology evolution, customer satisfaction, reconcilement, exception processing and new product development.
• The increased use of standards will make more connectivity possible and increasingly necessary. Increased connectivity will reduce re-keying of data, increase the use of exception-only processing, and establish the opportunity for outsourcing. Businesses that used to make their best margins from inefficient markets will have to change their product mix in order to survive.
• Fewer, stronger players will struggle constantly to differentiate themselves but standardized processing will force firms to differentiate in non-traditional ways. A few global mega-players will emerge to dominate the securities processing environment, but their very size will create opportunities for boutique firms seeking niche opportunities.
• Highly automated processes will reduce costs and control risk, but customers will increasingly require customized solutions that will ultimately require more innovation and automation.
• Outsourcing will become essential as firms are forced to focus their best talent and energy on their core competencies in order to compete successfully. The pace of outsourcing will increase as firms realize that non-strategic functions should be removed from the firm

ROLE OF EXCHANGES

When considering the impact of these trends on securities exchanges it would be an understatement to describe these times as one of unprecedented change. Events that only a few years ago would have been considered impossible are now commonplace around the world. Floors are closing, exchanges are demutualizing and alliances are being formed and reformed. In the midst of this activity, some common themes regarding exchanges are emerging:

• Electronic markets have expanded the potential universe of users from local floor traders to firms and individual investors located anywhere in the world.
• Regulatory changes that are designed to level the investment environment favor the implementation of electronic solutions.
• Exchanges are facilitating access to electronic markets by bifurcating membership rights and execution access.
• The convergence of these markets has placed additional emphasis on efficient use of capital in the clearing process.
• The demand for access to these markets is driving the industry towards twenty-four hour electronic markets.

Since these developments are happening so quickly and with such force that organizations run the risk of becoming captive to the energy of the process, it is appropriate to review the three areas where an exchange can add value in the future.

EXECUTION SERVICES/ MARKET ACCESS

It is here that technology has had the greatest impact; weakening if not destroying long held views that established liquid markets are natural monopolies. Future customers will likely access markets from workstations connected to open architecture networks via multiple, connected order routing mechanisms that are provided by competing ECNs and the exchanges themselves.

Exchange success requires the ability to cost effectively provide electronic access on a global basis, 24 hours a day.

SELF-REGULATORY SERVICES

Exchanges, by their nature and definition, are self-regulatory bodies. This function, which can be unbundled from the clearing and execution services, is the least discussed value-added service an exchange offers. To minimize operating expenses, the provision of regulatory services can be subcontracted; however, ultimately the liability associated with the provision of these services must be recognized.

CLEARING SERVICES

Risk management, counter party credit risk, the efficient use of capital, and equity return for equity risk dominates the current discussion regarding the provision of clearing services. Exchanges that can efficiently match, 'lock-in' trades and communicate electronically to clearing agencies will help firms reduce errors and costs, especially in the US as the regular settlement period shrinks to one day.

In summary,

• Exchanges add value, and properly managed, can continue to add value.
• The movement to demutualize will continue.
• The development of new electronic exchanges will continue.
• Equity participation and/or strategic alliances involving investment bankers, telecommunication firms, cash market operators and new or existing exchanges will continue.
• An exchange, to be successful must offer all three services in a cost-effective environment.

THE REGULATORY CLIMATE

The origins of the current situation began with the SEC's creation of the National Market System in 1975 and their Market 2000 study in 1997. The goal, as spelled out by the Division of Market Regulation in its December 1998 release, was to devise "market practices and structures that could affect the ability of customers to obtain opportunities for better prices."

Much of this was the result of the 1997 OTC pricing scandal. At that time, the SEC found that order flow information was being turned into profits as dealers bought and sold with spreads that were wider than justified by the market. That activity has been deemed to be a violation of the anti-trust law.

The SEC's responded to this and other trends by establishing two key regulatory events that led to the rise of ECNs.

• In April 1996, the SEC passed rules on order handling that required the display of customer limit orders, and amended a rule governing the publication of quotations to enhance their quality and efficiency. The end result was that it gave ECNs access to the NASDAQ market.
• In December 1998, the SEC determined that ECNs could register as broker-dealers or as exchanges. Registering as an exchange requires them to become self-regulatory agencies (SROs), which is more costly than being a broker due to the requirement for self-regulation and on-going surveillance. Although it is more expensive to be an SRO, as exchanges these ECNs would be allowed to connect electronically and trade stocks that are listed on NASDAQ and other US exchanges.

"The 1996 rules were the first time the term ECN was used in an SEC document," Heine said. The rules were implemented in January 1996, and created the opportunity for ECNs to directly trade on the NASDAQ market system. The 1998 SEC statements modified the regulatory framework for an ATS - and changed the definition of a stock exchange." That controversial change said Heine, was accomplished when the SEC changed its order handling rules, which amended the 1934 Act.

By registering as an exchange and becoming an SRO, an ECN has access to NASDAQ and to the Intermarket Trading System (ITS). Operated by the Securities Industry Automated Corporation (SIAC), the ITS links exchanges throughout the US and thereby expands the reach of an ECN. As exchanges, ECNs can also trade options and use the Options Clearing Corporation and trade options.

The SEC wrote, "The technology driven cost-reductions have allowed automated markets to develop and compete with the traditional exchanges." The SEC noted that "alternative trading systems have been regulated [in the past] like broker/dealers, even though they were markets. The [new] SEC regulations were designed to integrate ATSs into a regulatory framework."

Although the SEC's regulatory changes were complicated, the action was taken since Alternative Trading Systems could no longer be ignored due to the trade volume they had acquired. In an April 16, 1999 release, the SEC stated, "The operational failure of a major [ECN] could interfere with the markets as whole." The SEC's fears about liquidity and the impact of unregulated activities on the market couldn't be clearer.

A 1995 survey by Institutional Investor's Trader Forum found that while traders frequently delayed trades to obtain better prices, electronic trading was well received. "There is a generally positive view of alternative electronic trading systems, such as Reuters' Instinet and Investment Technology Group's POSIT," the report stated. "The key motives for trading on these systems are reduced market impact, lower spreads, better liquidity and anonymity." According to respondents, the key changes that would increase ECN use were increased execution rates and more convenient times of trading. Traders told Institutional Investors' survey that they would move even more volume to ECNs if they did not have soft dollar arrangements.

The evolution of ECNs continues to blur the lines between exchanges, technology companies, brokerages and banks. "People are groping with this area because it's so new," said Monte Wetzler, a securities attorney and partner in the law firm Brown, Raysman Millstein Felder & Steiner. With the ECN landscape in flux, there's no reason to believe the regulators or the securities industry will stand still. Recently elected Senate Banking Committee member Chuck Schumer (D-NY), advocates more regulation for ECNs and a requirement that they all display the best price for stocks, even if the price originates on another market and even if an ECN does not register as an exchange.

Gerald Putnam, CEO of Archipelago is as concerned about regulation as he is about competing ECNs. "Archipelago's threats are not necessarily from our competition but from potential regulatory or political changes. Accordingly, we continue to offer input into the policy making process with the SEC, NASD and other market participants."

Island's General Counsel Cameron Smith said that while he expects the ECN to perform the same oversight of trading as is done on the NYSE and NASDAQ, its not clear who will examine Island's books. On August 5, the Securities Industry Association (SIA) announced that it asked the SEC to postpone the launch of Opitmark's trading system on NASDAQ on the grounds that the clearance of trades could be put at risk. Optimark and NASDAQ have acknowledged that there are problems, and SIA believes they should be addressed first.

CONCERNS REGARDING ECNS

Despite the lack of regulatory specificity, and perhaps because of it, ECNs have become a major force in the securities industry. Due to this growth, there are two main areas of concern: segmentation and shakeout.

• As more ECNs enter the field, market share will likely become more segmented for a time.
• However, once the ECN market becomes over-saturated, and this level may be fast approaching, the industry will almost certainly be stabilized through mergers and acquisitions.

Neil DeSena, managing director of Spear, Leeds & Kellogg told Institutional Trading Technology that "liquidity is what makes an ECN go." But, some industry observers believe that the acid test for ECNs will be how they perform in a bear market, something that is hopefully not on the horizon in the near term. In a bear market, the current level of rapid growth could be quickly reversed, and a shrinking volume would likely cause a shakeout at the low end of the ECN market.

Indeed, doomsday scenarios of all types are behind the SEC's regulations, and the Commission is hedging its concern over a possible crisis against the benefits ECNs have to offer. "The SEC is saying that there is a possibility of market disruption should something occur with a major [ECN]," John R. Hewitt at attorney at Mayer, Brown & Platt told the New York Law Journal. "They are concerned that if there is not a better ... mechanism to regulate these entities, the transparency in the marketplace will be diminished."

While transaction costs are lower with ECNs, price transparency and prices discovery may suffer if volumes are overly segmented during a period of reduced volume. A seller who can't find a match or anyone to meet his limit price through an ECN or a network of interconnected ECNs will be forced to settle for less or nothing at all, and in this sense, ECN trades are the equivalent of a fill or kill order. This is not necessarily the case with a limit order that has been sent to a specialist on an exchange floor or to an OTC market maker.

• A NYSE specialist could complete the trade to maintain liquidity or satisfy a customer relationship by buying the stock for their own inventory at the asked price.
• An OTC broker can seek a different market maker if the desired price is not available on NASDAQ.

In fact, concerns over the delivery of pricing led the SEC to delay the implementation of the rules governing ECNs, which were adopted in December 1998. All but one of the rules went into effect on April 16, 1999; and as a result of that exception, ECNs will not be obligated to make public the prices and sizes of their best-priced buy and sell orders unless the trade is for a security in which more than 5% of the total trade volume occurs on the ECN.

This pricing provision will be phased in over four periods in August and September 1999, and April and June 2000. The SEC said it delayed implementation because a major ECN was unable to upgrade its system in time to be compliant. That system is believed by some to be Instinet. While it is the biggest, it is also the oldest and is believed to be wrestling with a legacy infrastructure. Newer ECNs entered the market with databases and reporting systems that were already SEC compliant.

In registering as exchanges, the ECNs may be incurring costs that they are not fully prepared to meet over the long term since it is not clear that the gain in revenue from becoming an exchange won't be off-set by the cost of becoming a self-regulatory agency. The NYSE spends over $500 million a year to meet its responsibilities as an SRO. New SEC rules on this matter have been designed to help both traditional and electronic exchanges, and lighten the regulatory burden on the ECNs, which had been subject to the more onerous requirements.

But for an untested ECN, paying the self-regulatory costs may be more than it can afford. "The exchanges have devoted tremendous resources to enforcement and market surveillance for many years," said former senior SEC enforcement Richard Marshall, now a partner at the law firm Kirkpatrick and Lockhart. "Whether or not you can expect a new entrant to do that is another question. You don't just install that in two days. You have to build it, and it's extremely expensive."

NYSE AND NASDAQ RESPONSES TO ECNS

The responses of the New York Stock Exchange and NASDAQ could significantly affect the movement towards electronic markets, and it may now be a question of who goes public and gets to the market first with an IPO and acquires sufficient capital to invest in an ECN or ECNs. The SEC opened the door for this possibility by allowing traditional exchanges to set up broker/dealer trading systems in order to experiment with electronic trading. In what was a forward-thinking move, the SEC recommended that regulated exchanges such as the New York Stock Exchange and the NASDAQ try out try out their own alternative trading programs, free of regulation, and allow exchanges to trade new derivatives securities without SEC approval. Instinet's Doug Atkin told the Wall Street Journal that it would establish an arrangement with the NYSE or NASDAQ only if they went public, which he said would lead to a "much deeper, more liquid New York Stock Exchange, which will be better for everybody, including our clients."

NYSE

The 207 year old New York Stock Exchange, which has lost volume to the ECN trend, has delayed their plans to extend their trading day in favor of taking the exchange public. One benefit the NYSE would derive from becoming a publicly traded entity is the ability to rapidly raise capital and acquire leaner, more flexible rivals, which would almost certainly be one or more ECNs. Questions remain as to how NYSE seat holders would relinquish their assets and how the accompanying tax matters would be handled once the seats were sold.

Would this 'if-you-can't-fight-em, join-em' strategy allow the NYSE to continue to compete as a trading floor, or merely delay what some perceive to be the inevitable? Again, the volatility in the field makes predictions difficult, but Chairman Richard Grasso's preference to issue an IPO by Thanksgiving suggests that the NYSE may feel that it has already waited too long to respond to electronic trading. While a protracted bear market seems very distant, it would take little more than a short term plunge at about the time the NYSE's IPO came out to compromise the deal. And, said Credit Suisse First Boston's Internet analyst Bill Burnham, "To get an above market multiple, they'd have to have a convincing story of why they're [going to be] a winner."

Seat holders of the American Stock Exchange, the nation's second largest auction market for equities, can look forward to no such windfall. Amex members sold their stake in the exchange when the NASD acquired it last year in exchange for promises that the NASD would make a $100 million investment in technology that the Amex could not afford. Although Amex seat prices have gone up, its old technology has generally not yet been replaced and new listings have been scarce so far.

Meanwhile, the National Association of Securities Dealers has not only approved a stock offering for NASDAQ, but it is seeking alliances with the ECNs that have been taking its market share. Michael Brown, a NASD board member and former CFO of Microsoft, was reported by the Financial Times of London (July 31) to be coordinating the negotiations with these companies. Rather than have to wait until Thanksgiving, NASD Chairman Frank Zarb recently said, "We'll be consulting with the greater membership in a couple of weeks." Zarb also said that no public offering would be made until its 5,500 broker/dealers became a part of the decision.

The ECNs may have already influenced NASDAQ to make some structural changes. "We need to change our order display window to give more investors more visibility into the market," he told the Financial Times. And, in a separate announcement, Mr. Zarb said that NASDAQ/AMEX will create an electronic futures exchange.

Meanwhile, the New York Stock Exchange and the NASD have held joint discussions about combining their regulatory arms, which may lead to the exchanges operating on a for-profit basis, together or in some form of partnership. The threat posed by the ECNs has made what would have been unthinkable only a short while ago open for discussion.

"This is a remarkably changing environment," NASD President Richard Ketchum told CNBC News in May. We've had conversations with everyone. We'll never say never. There are many things that might work better combined between [the NYSE] and ourselves - particularly providing a single self-regulatory service together."

Other exchanges are also faced with the need to adapt. While the 117-year-old Pacific Stock Exchange is doing well in options, it lost money in its equity business last year. The Wall Street Journal reported that the PSE's board of directors voted last month to turn its stock operation into a for-profit subsidiary and plans to close its stock floors in Los Angeles and San Francisco. The PSE could score a major advantage by hooking up with an ECN before the New York Stock Exchange or NASDAQ.

CONCLUSIONS

"You can never plan the future by the past."

- Edmund Burke, in a letter to a member of the English National Assembly, 1791

No one really knows what the future holds, or how long it will take for the landscape to be re-arranged. However, it is clear that:

• Even though the Internet and other forms of electronic communication support the potential for a very large number of specialty ECNs, the reality is that the regulatory burden requires them to maintain a measurable share of the market in order to be profitable. It is unlikely that many more ECNs will be established due to the existing over-segmentation.
• Because of the cost pressures, ECNs and ATSs will begin merging or will be acquired. In fact, some of the later entrants may have been established only with a view to being acquired. Some recent activities have included:
• Instinet purchased a stake in Archipelago
• Bloomberg has announced plans to form a Super ECN with POSIT
• REDIBook has announced that it is ready to form an ECN with Charles Schwab, Fidelity and DLJDirect
• Island has made a platform integration agreement with BRUT
Strike is discussing an alliance with POSIT and the Arizona Stock Exchange
The SEC is constantly monitoring the impact of these new forms of trading, and will continue to evolve the regulations affecting ECNs and other forms of electronic trading. NASDAQ's stated "network or networks" objective is already being met by having the ECNs connecting to it, but NASDAQ's profitability would increase by acquiring selected ECNs.
• The NYSE must participate in the move towards electronic markets or be disintermediated. Demutualizing is probably the first step in this direction.
• Open architecture ECNs have a greater chance of succeeding than closed systems.

APPENDIX I - ELECTRONIC COMMUNICATIONS NETWORKS

The following nine ECNs that were established as a result of the SEC's order-handling requirements and are registered as either brokers or exchanges with the SEC. Some of the ATSs in Appendix II may also soon be registered.

Although there are nine ECNs, two have 90% of the market.

Technology is a critical part of an ECN, and Instinet's market share strength came as a result of being first to the market. The result of being first is having the oldest technology.

Owners: Goldman Sachs, E-Trade, J. P. Morgan, Instinet

Originally owned by Archipelago Holdings and Terra Nova Trading, financing was once as problematic as its market share, but this company's prospects have changed very quickly.

Archipelago has had plans to register as an exchange, but until recently it was unclear how it would finance such a venture. But when E*Trade Group Inc., Goldman Sachs Group Inc. and JP Morgan became investors earlier this year, Archipelago's viability increased. What no one expected was the July 28 announcement that Instinet was also buying a stake in Archipelago, since Instinet's Douglas Atkin previously told the New York Times [7/28] he did not consider Archipelago a competitor.

This was clarified by a subsequent statement. "We didn't buy into what Archipelago is now, but what it wants to be, which is a for profit exchange. In the medium term, that is not the area of financial services we went to play in. [Instinet is] striving to be a global brokerage firm. I think those strategic differences make this a complementary relationship."

Currently, about a third of Archipelago's volume comes from broker/dealers trading for their own account, one third from institutions and rest from individuals. Archipelago is looking to increase its business in all three markets.

Archipelago's greatest strength is in its open architecture, which allows it to access other ECNs when looking for a matching trade, while the other existing ECNs are also closed systems and are only connected to NASDAQ.

Ownership: All-Tech Investment Group

Even without considering the recent deaths of four people in its Atlanta, Georgia offices, Attain's heavy-handed approach seems to embody some of the worst tendencies of day trading firms, which is Attain's niche. CEO Harvey Houtkin has proclaimed himself "the father of electronic trading" and "the original SOES bandit" among other self-serving pronouncements. Attain's website features a banner that reads "All-Tech Training Group Invites You To Trade With The Experts" and is clearly an appeal to amateur traders. Its website also advertises a four-phase training program as part of All-Tech's "continuing education program." The fourth phase is available only to those who open an account with Attain.

The subscribers match orders internally while non-subscribers can access Attain via SelectNet. Attain is counting on electronic trading, specifically day trading, to go mainstream and targets broker/dealers along with retail customers and day traders. It is also hoping to compensate for its also-ran status with its connectivity with Island and Archipelago and is hoping to have similar connections to BRUT, Strike Technologies and REDIBook.

Ownership: Bloomberg

Bloomberg's Tradebook, formerly known as B-trade, services institutional customers only and continues to ignore retail business. It also has a secret weapon: access to existing Bloomberg customers. Tradebook relies heavily on an existing client base of Bloomberg Terminal users and is trading heavily on name recognition. Bloomberg is believed to have pioneered functionalities that enable participants to conceal their true position or the size at which they're willing to trade.

A recent deal with Credit-Lyonnais is part of a strategy to become a so-called "Super ECN" called Tradebook Super ECN. The Super ECN concept was further advanced with the July announcement with Investment Technology Group (ITG), which makes crossing systems such as ITG Platform and POSIT.

Bloomberg's Lou Eccleston told Wall Street Technology that the benefit of a Super ECN is immediate access to a continuous and to a crossing market. More importantly, it would involve the creation of a platform that would trade on the NYSE as well as the NASDAQ. But Bloomberg is undecided as to whether it will register as a broker or an exchange, and the participation of an SRO is a requirement for the Super ECN concept to work.

No official launch date has been established for the POSIT partnership.

Like Instinet and Bloomberg, BRUT, which is owned by Automated Securities Clearance (ASC), a division of Sungard Data Systems, has been planning on leveraging an installed client base, but it remains significantly smaller than Bloomberg so far. The company claims to be used by 175 brokerage firms that represent 50% of the NASDAQ volume. To date, technology issues have prevented then from succeeding in the retail market.

BRUT users that are members of the Brokerage Real-time Application Support System (BRASS) can avoid leasing a private line, buying or leasing a Sun server, routers and other connection costs. Currently, its niche is among NASDAQ broker/dealers, but in June it made a strong move into the integration area by making a deal for its platform with Island.

The introduction last July of BRUT's equity market access system, UMA, has lead to a 30% increase in BRUT's volume. UMA offers access to NASDAQ quotes and the BRUT book. BRUT investors include Merrill Lynch and Goldman Sachs, Knight/Trimark, the biggest market maker on the NASDAQ exchange.

BRUT plans to register as an exchange.

Ownership: Reuters

Currently the biggest ECN, Instinet's trading volume has ranged from 15% to 20% of NASDAQ shares. Instinet has recently purchased a controlling interest in Tradepoint, the troubled UK electronic exchange which was expected to compete with the London Stock Market and has purchased an interest in W.R. Hambricht & Co., and its subsidiary that plans to offer IPOs over the Internet. While Instinet is also planning to move into the retail equity and fixed income markets, it has no plans to register as an exchange. In fact, Instinet insists on emphasizing that it is primarily a broker/dealer.

While Instinet is considered to be the first ECN and the industry generally feels that the SEC's regulations were initially a response to Instinet's success, Instinet's management regularly states that it is not an ECN and continuously refers to itself as a broker. This is likely because, in addition to having a sizeable number or brokers doing business by phone, it plans to offer block trading, listed trading, soft dollar accounts, trading-cost analysis and research analytics which it would like to turn into separate businesses rather than ECN add-ons. In December 1998, Instinet expanded its direct order entry capability using FIX protocols that has been integrated into the order management and routing system.

It is also planning a new IT platform for its core equities business. It's IT budget for 1998 was over $100 million and will likely reach those levels again this year. The SEC mandate for improved order display means more data traffic plus a demand for better telecommunications capacity and more efficient technology.

Yet as part of its plan to diversity, Instinet is also likely to move away from equities. Although volume has skyrocketed, per-trade profits are being squeezed. Some observers believe Instinet's move into fixed income may be ultimately more significant than its efforts in the retail market. Instinet is already a standard on institutional desks, where most fixed income business is found. Instinet's strategy is a microcosm of where ECNs are headed: the retail market will become as sought after as the institutional market and other instrument types.

By the mid 1990s, Instinet had become the dominant NASDAQ broker, which some observers believe led to rigid pricing policies that became a liability once there was significant competition from other ECNs. In July, Instinet acquired a 16.4% stake in the ECN Archipelago. The Wall Street Journal reported [July 28] that this now gives Instinet 30% of NASDAQ's volume.

"It's inevitable that that there will be major consolidations over the years," Instinet's Doug Atkin told the Journal. "We think Archipelago is going to be on of the winners." Is Instinet's investment in Archipelago a sign of Reuters' belief that Instinet, despite its market share, is inherently flawed as an ECN? Or, as Atkin said, is it part of an overall growth strategy?

Instinet has recently expanded its global brokerage operation and, the Journal said, cut back its reliance on being an ECN. Jim Marks, a Deutsche Bank Alex Brown analyst told the Wall Street Journal that the deal with Archipelago might indicate that Instinet is unsure of "the viability of their version of the ECN business."

Instinet's vision may change drastically in the future, but if there is a shakeout, the potential field of dozens of ECNs will be whittled down to two or three, and it would be surprising if Instinet was not among the survivors.

Island is a Silicon Alley cliché although it is located in the heart of the NY financial district. Despite its grungy offices and T-shirt clad staff, it controls about 5% of the total volume of NASDAQ stocks and is second to Instinet in total ECN volume with 20%. Unlike Instinet, it discovered the retail market early on, and is the largest ECN serving individual investors, including day traders.

Island has been more successful in raising money than most of its competitors. Island has applied to the SEC to become an exchange and was the first ECN to ask the SEC for clearance to trade shares on NASDAQ and the NYSE.

However, the Manhattan District Attorney's office has been investigating the activities of Datek Online Holdings, Island's parent, and its possible role in a money laundering scheme, which resulted in a cancelled IPO last year. Datek was named, but not charged, in a Federal indictment in Florida last June that accused an individual of illegally using a Datek Securities account to transfer $2 million to an offshore bank.

The SEC is also investigating illegal trading practices at the firm. Datek founder Jeff Citron, and former Datek owner Sheldon Maschler have been fined in for improper supervision of traders and last May, the SEC fined Datek for filing false financial reports and illegally using customer funds to pay its own bills in April 1998.

Vulcan Ventures, a capital fund backed by Microsoft co-founder Paul Allen, pulled back part of a planned $300 million investment last July, two months after plans to fund Datek were announced. Vulcan also dropped plans to buy a 12.5% stake in Island.

Reports in the New York Times [July 22] and elsewhere indicated that Vulcan's contributions were earmarked to allow Island to comply with SEC rules and establish themselves as an SRO. While Wall Street has praised Datek for its prowess as an online brokerage firm, its troublesome history has raised concerns about its credibility. Vulcan cited "due diligence" problems as the reason for pulling out.

But in what was a stoke of luck, the money Vulcan held back was replaced within 24 hours by Group Arnault of France and TA Associates, a Boston-based venture capital firm. Datek announced that it will be able to continue with plans to expand its workforce and spend $100 million on advertising.

Without the benefit of big money backers such as those that are behind BRUT and Strike, NexTrade has expanded from a stock quote system five years ago to an ECN that offers 24 hour trading for the buy and sell sides. It is also planning to register as an Exchange.

Founded in 1996 as an electronic brokerage for day traders, NexTrade developed an order matching system in 1998. It claims to have built databases to accommodate stocks, options, bonds and mutual funds on a single matching engine called SmartMatch with built-in ECN access, but also has stand-alone software for the retail market.

In October, NexTrade plans to expand its trading system to eleven European countries and Canada and will include listed stocks when it gets approval to operate as an exchange.

REDIBook's owner, Speer, Leeds and Kellogg (SLK) first developed REDIPlus, its proprietary computer interface and trade matching engine, then it launched REDIBook, an ECN designed to run out of data centers in New York and New Jersey

In its capacity to match trades, REDIBook has connectivity with the NYSE, Amex, SelectNet, SOES (Small Order Execution System) and NASDAQ. This is a key attribute that in July led Charles Schwab Corp., Fidelity Investments and online broker DLJdirect to tap REDI when a four-way partnership was announced. Each company is reported to own 25% of the new venture.

Although the new ECN does not have a name and its hours of operation are not clear, it plans to offer extended hours trading. And while the Fidelity/Schwab/DLJ ECN is right now nothing more than a one time headline, it could be a wild card in the ECN sweepstakes.

In June, REDIBook passed Bloomberg's TradeBook in NASDAQ volume according to NASDAQ Trader, a NASDAQ website. REDIBook, which has registered with the SEC as an exchange and as a broker, could move from also-ran status to one of the top three ECNs.

Strike has been in business since early 1999, and is an all-comers ECN with credit-worthiness being the only customer requirement. Institutions, market makers, professional investors and broker dealers may apply. Its pay-as-you-go system features a sliding scale fee structure based on cost-per share volume.

An example of the low end of the ECN market, Strike offers no analytics. However, there is nothing low end about its investors, a consortium lead by Bear Stearns which includes Salomon Smith Barney, Paine Webber and Herzog Heine Geduld, who are counting on a market for individual investors who want to avoid brokers fees.

Strike is also intent on establishing links to ITG POSIT and the Arizona Stock Exchange.

APPENDIX II - ALTERNATIVE TRADING SYSTEMS

Sometimes known as Third Markets, ATSs are the precursors of ECNs. The ATS market accounts for about 20% of the NASDAQ market and about 4% of transactions in listed securities.

ATSs can register with the SEC if they want to become either a broker or an exchange, and thereby become an ECN.

Opened in 1990, the AZX is was initially a proprietary electronic call market system developed by Steven Wunsch, who was contacted by the Arizona Stock market, a creation of the Arizona state legislature, and invited to form a partnership.

The AZX call market consolidates supply and demand into one large daily trade that takes place after a consensus is reached on price. Because price is determined in a competitive auction, this type of price discovery leads all investors to trade a single security at a single price on that day. Price spreads, market impact and extraneous turbulence usually found in continuous markets are eliminated. AZX can be viewed on its website. Investors must have an account with ITG, AZX's executing broker, or a broker with an ITG account.

The AZX has been established as a call market, and does not have to register as a stock exchange with the SEC, because the SEC has granted AZX an exemption due to its low volume.

Contact Brian Hyndman, President, bhyndman@cobra.brass.com

Technology requirements: Humingbird/Exceed-X Windows; Unix Solaris

Volume per day: 7 million shares

BRASS is an order routing network and management systems network developed by Automated Securities Clearance. Brass customers connect via BNET - the Brass Network, which includes a crossing network. BRASS says that it crosses about 80% of the volume in the NASDAQ market, which led to the formulation of BRUT. It is well regarded in the securities industry because of its built-in compliance functionality that aids in meeting regulatory requirements. BRASS has aided firms in complying with the NASD's recent Order Audit Trail System (OATS) rules.

Volume: N/A

Technology requirements: Optimark supplies servers and GUI, plus dedicated communications lines. Users provide PC-to-host link.

Optimark, an electronic share trading system backed by Dow Jones and IBM, emerged as a key player in 1999 as an Alternative Trading System. It matches buyers and sellers in a frequent call market using algorithms to match buyer and seller profiles.

Optimark is a software application that can be purchased and used by an exchange. It is not itself an exchange or broker, and currently has no intention of changing this model. NASDAQ and the Pacific Stock Exchange are currently using Optimark.

According to Optimark, their screen-based trading system will facilitate price discovery regardless of trade size and "enable traders to express their entire trade strategy, regardless of complexity and without disclosure." Optimark has scored high marks among users for its anonymity. With NASDAQ and the Pacific Stock Exchange signing on as Optimark clients, some observers believed that Optimark might become a serious competitor to POSIT.

On July 12, Institutional Trade Technology reported that Softbank Capital Partners planned to invest $100 million in the electronic trading system. In August, Optimark plans to begin operation at NASDAQ.

However, the Securities Industry Association, citing clearance risks, has asked the SEC to postpone the launch on NASDAQ. SIA's objections were outlined in a comment letter to the SEC - which is middle of making a decision on Optimark's use by NASDAQ. SIA claims that NASDAQ and Optimark officials have admitted that there are problems that will make risk management more difficult. An Optimark spokesman said in July that the launch on NASDAQ was planned for the current quarter, but this was not verified by anyone at NASD.

Volume traded: 24 million per day

BARRA research described POSIT as the "World's largest intraday equity crossing network." Originally a joint venture with the Jefferies Group, ITG was recently spun off by the New York-based institutional broker.

POSIT is a confidential trading system that matches bids and offers six times a day, pricing each trade at the midpoint. Ben Mattlin reported in the November 1998 issue of Sellside that the 1998 weekly trading volume on POSIT far exceeded expectations. Volume rose from an estimated 15 million shares per day at the beginning of the year to 26 million per day.

Unlike Optimark, which is a single-stock oriented system, POSIT is oriented toward portfolio management. It allows clients to optimize portfolios just before executing trades, giving them an opportunity to lower costs and to better control the outcome.

In a similar way that the Arizona Stock Exchange is not considered an exchange by the SEC, POSIT, while registered as a broker, is not ranked as an ECN.

APPENDIX III - GLOSSARY

Most of the following terms have been extracted from Securities Operations Glossary.

Alternative Trading System	An Alternative Trading System (ATS) is a networked application that connects potential buyers and sellers of securities electronically, and matches trades that meet predefined criteria. ATS See Alternative Trading System
Call Market	In a Call Market, purchase and sale intentions are accumulated and are then matched at one or more derived pricing midpoints during the day.
Continuous Market	A Continuous Market is a stream of individual purchases and sales that are matched as trades, with each trade having the potential to affect the price of the next trade. Exchanges, NASDAQ, and manual OTC trading provide continuous markets.
Crossing Market	In a Crossing Market, various purchase and sale limit orders are held until an offsetting match is presented. At that time the trade is matched and the counterparties are notified of the trade.
ECN	The abbreviation ECN has three meanings:See Electronic Communication NetworkSee Electronic Crossing NetworkSee Electronic Confirmation Network
Electronic Communications Network	An Electronic Communications Network (ECN) is an Alternative Trading System (ATS) that has been registered with the SEC as either a broker or an exchange.
Electronic Confirmation Network	See Electronic Trade Confirmation
Electronic Crossing Network	The term Electronic Crossing Network is used to describe either an Alternative Trading System or an Electronic Communication Network.See Electronic Communication NetworkSee Alternative Trading System
Electronic Trade Confirmation	Electronic Trade Confirmation (ETC) has two different meanings:The Industry User Group (IUG) was formed by a group of brokers and investment managers, who selected several vendors to for the Inter Vendor Link (IVL) in the United Kingdom.ETC vendors are a new category of SWIFT participant. ETC vendors provide their customers with connectivity and message routing.
Initial Public Offering	An Initial Public Offering (IPO) is the initial offering to the public of a new issue of a security. IPOs are distributed in the primary market.
Intermarket Trading System	The Intermarket Trading System (ITS) is a computer system, operated by SIAC, that links the communications systems of exchanges throughout the US in order to find the best market for investors and prevent arbitrage, including the US stock exchanges, the CBOE and NASDAQ.The system enables market professionals to interact with counterparties in other markets whenever the nationwide Consolidated Quotation System (CQS) shows a better price.
IPO	See Initial Public Offering
ITS	See Intermarket Trading System
NASD	See National Association of Securities Dealers
NASDAQ	NASDAQ is an electronic network that is used to store quotes, access quotations, and trade selected over-the-counter securities. Level I service provides the best bid and offer for a security without identifying the market maker. Level II service provides the best bid and offer and identifies the market maker. Level III service allows registered market makers to compete and trade by entering their own bids and offers.
National Association of Securities Dealers	The National Association of Securities Dealers (NASD) is the rule making body that governs the over-the-counter brokerage industry. The NASD, a self regulating organization, is organized to "adopt, administer, and enforce rules of fair practice and rules to prevent fraudulent and manipulative acts and practices, and in general to promote just and equitable principles of the trade for the protection of investors."NASD is responsible for the operation and regulation of NASDAQ and the over-the-counter securities markets.
SEC	See Securities and Exchange Commission
Securities and Exchange Commission	The Securities and Exchange Commission (SEC) is the primary regulatory body that governs the securities industry. Created by Congress with the Securities Exchange Act of 1934, the SEC is an independent, bipartisan, quasi-judicial agency of the United States Government. The SEC is managed by a Board of Governors, which is led by a chairman.The laws administered by the SEC deal with securities and finance and seek to provide protection for investors in their securities transactions.
Super ECN	A Super ECN is an ECN that has access to continuous markets (NASDAQ and exchange listed stocks), as well as crossing markets that are provided by non-ECN Alternative Trading Systems.
Surveillance	Market Surveillance is the automated process of investigating illegal, abusive or manipulative trading practices. Market Surveillance tends to prevent most people from breaking the market's rules and regulations.