The wind it was howlin’ and the snow was outrageous.
We chopped through the night and we chopped through the dawn.
When he died I was hopin’ that it wasn’t contagious,
But I made up my mind that I had to go on.
– Bob Dylan and Jacques Levy, “Isis”

That sums up the weather conditions in these parts at the moment. But I’m not chopping through the night or the dawn or anything else at the moment; just sitting on the couch. I told my wife I couldn’t go out and shovel the walk just yet because I had something to do for work. So I made up my mind that I had to go blog.

A few items before shutting down ’til 2009:

Here are the new circuit-breaker levels for the first quarter of 2009.

US Regulators Poised To Miss Deadline For CDS Clearing (Dow Jones, via EasyBourse) Excerpt:
A pact between three U.S. financial regulators to coordinate approval of central clearing for credit derivatives is showing cracks as their year-end start-up deadline approaches. …
The Federal Reserve, the Commodity Futures Trading Commission and the Securities and Exchange Commission have collectively approved only one of the three clearing proposals from U.S.-based exchanges. …
While NYSE Euronext (NYX) received the go-ahead last week for a U.S. operation, following the launch of its European platform, credit-default swap clearing proposals from CME Group Inc. (CME) and IntercontinentalExchange Inc. (ICE) still await the green light from some regulators.

My take on that issue: coordinated would be good; fast is paramount. These platforms will help reduce risk and increase transparency, and our economy needs all of those goods, sooner rather than later.

NYSE Euronext: Rebound Likely Zachary Scheidt, via the Seeking Alpha blog) Excerpt: Over the past year, NYX has had to play defense as changing technology and volatile markets have pressured the company. The NYSE floor and open outcry system are quickly becoming a thing of the past, and the exchange has had to scramble to keep up with competition. But hefty investments in new platforms have increased the performance of its systems and it now appears that NYX is winning back business from competing exchanges.

I can’t comment on our stock price, as NYSE Euronext doesn’t offer guidance. But I can tell you that the NYSE Trading Floor and their electronic tools are an integral part of our beginning to win back business and are on their way to becoming a trading model for the future, not a thing of the past. Will invite Zachary in for a first-hand look.

BEST STOCK MARKET BLOG POSTS OF 2008! (Clean version) (Dinosaur Trader) — DT has again asked more than two dozen members of blog gang (including your humble blogger) for their favorite posts of the year. Some good reading here. And DT himself writes a couple of sentences introducing each post. On the “clean version” linked here, those intro’s are PG-rated. On the other version, DT spiced up the intro’s to generate a little more traffic, and they’re R-rated and heading toward NSFW (that’s not safe for work, for you Web newbies). I can’t link to the second version on this G-rated blog, but it’s not hard to find either. And it’s funny. Hey, I had to check it out — it’s my job! Really it is!

The good folks at the Seeking Alpha blog for the first time picked up an Exchanges post, and offered to pick up some others now and then. That prompts me to dust off my five-word acceptance speech: “There must be some mistake.” Seriously, thanks, SA; glad to join you.

Time to grab that snow shovel now. Reminder: full trading day on Friday, Jan. 2, 2009. See you there. One last bit of historical trivia for the year:

Today in NYSE History
31 Dec. 1999 — The NYSE closed at 1:00 p.m. to allow technicians to prepare for the possibility of “Y2K” computer glitches. There were none.

Ah, Y2K. I was one of many lucky colleagues who “volunteered” to work that historic millennium-beginning New Year’s Eve. A few of representing different areas of our business were holed up in a conference room all night, surrounded by PCs and phones, ready for anything. Here is an excerpt from my notes that night.

12:00 a.m.: Lights still on. Phones working. Systems fine. Good work, folks.
12:05 a.m.: Lights still on. Phones working. Systems fine.
12:10 a.m.: Lights still on. Can we go home now?

Happy New Year to you all. Easy on that egg nog. Aw, what the heck, go whole-hog on the egg nog. As my grandmother used to say, “Eh! It’s a holiday!”

News articles about the Madoff scandal are beginning to focus on Madoff’s earlier days in the business, when he and his firm were best known as the leading practitioners of “payment for order flow,” and as driving forces behind the growth of the “third market” as well as Nasdaq. In this post I’ll parse two articles on the topic that have appeared in the last few days, as well as a relevant blog post.

SEC inaction that helped fuel scheme (FT. com) Excerpts, along with my own comments:

…It was the SEC’s decision in the 1990s not to take a stand on the controversial issue of “payment for order flow” that helped fuel the rise of Bernard Madoff Investment Securities, the successful broker-dealer operation two floors above Mr Madoff’s private fund operation in Manhattan.

According to regulators and competitors, Bernard Madoff Investment Securities enjoyed at least a decade of outsized growth in the 1990s because it paid brokers for business and exploited wide bid-offer spreads in the market.

By paying for order flow, Mr Madoff’s firm siphoned roughly 10 per cent of the volume of trading on the New York Stock Exchange away from the specialist firms that dominated the Big Board’s floor, creating what was known as a “third market”. Then, according to competitors and regulators, Mr Madoff’s firm thrived by trading within the bid-ask spreads, which could be sizeable.

The SEC had a longstanding rule regarding disclosure of any “remuneration” received in connection with stock transactions. But, as the practice of brokers paying for order flow became popular in the 1980s, concerns were raised about whether the brokers doing the paying were buying stocks at the best prices for investors.

There you have both the nut of the article and the disclosure of my own bias. Payment for order order flow took business away from the NYSE. I also believed — and still do — that pay for flow deprived investors of the opportunity to get the best price; that is, the ability to trade at a price better than the published best bid or offer. It was notable that Madoff and the firms he was trading for engaged in pay for flow with orders from unsuspecting retail investors, not those of institutional traders.

In 1990, the NASD empanelled a group of experts to study the subject. The committee was headed by former SEC chairman David Ruder, and included Mr Madoff. The so-called “Ruder committee” delivered a report in July 1991 dubbed, “Inducements for Order Flow”.

The report found no legal basis for restricting the practice of payment for order flow, but recommended that the NASD require its members to disclose in advance the “factors that influence their order-routing and execution decisions”.

The committee included the leading practitioner of the strategy in question?

If my memory serves, the SEC later required firms to disclose to customers that they may have received compensation for directing their order to a particular market or broker, or may have traded against the order themselves (a practice known as internalization). This disclosure was implemented by the firms as generic, boilerplate language on trade confirmations, with little if any effect.

In the 1990s, then SEC chairman Arthur Levitt criticised payment for order flow in speeches, but he never restricted the practice. Mr Levitt says he often asked his counsel for market regulation to figure out a way to ban the practice, but those requests went nowhere.

I think that merits more explanation; why did the requests go nowhere — what happened?

The article goes on to explain how payment for order flow worked, and how immensely profitable it was for Madoff, until the introduction of decimalized stock prices shrunk spreads to as little as a penny. That meant it was no longer so profitable to pay for orders because the firm couldn’t recoup that payoff (and then some) by capturing the spread on every trade.

This article got me wondering about other things as well.

Was Madoff’s beginning as operating outside the established framework of markets the first indicator of future problems? In particular, was his treating trades as a commodity for his profit — not that of the customer — an early signal that regulators and investors should have heeded?

Given the NYSE’s dominance of trading at the time, it is understandable that Madoff seemed like a David versus our Goliath, and I recognize that we needed competition. But in the name of fostering that competition, was Madoff given too much regulatory leeway? And did the SEC’s allowing payment for order flow embolden Madoff to go on to bigger and worse things later? If he ends up on “60 Minutes,” I think that would be a good question for him.

Similar ground is covered in Rigged Games (Forbes.com). Excerpt:

…Bernie led a group of Nasdaq marketmakers who wanted a piece of the NYSE’s very profitable game. They argued they could give investors a better deal by bypassing the established exchanges and matching buyers and sellers more rapidly on their own computers. There was only one problem: The marketmakers were gaming the system, too. Madoff paid brokers to steer orders to his computers–as long as they were from relatively ignorant retail customers who didn’t possess information that could move the market away from him too quickly. The marketmakers also kept spreads at 25 cents or more by refusing to post offer prices in “odd eighths,” or 12.5 cents off the bid, and refusing to deal with anybody who broke rank.

…Watching over all this misbehavior was the National Association of Securities Dealers, which ran Nasdaq and was controlled by executives in the securities industry. Madoff served as Nasdaq chairman from 1990 to 1993, and his brother Peter was NASD vice chairman in 1993.

Marketmakers “had a cushy existence in the Nineties,” says William Christie, a finance professor at Vanderbilt University who exposed the spread manipulation in an influential 1994 paper. That ended soon after Christie’s paper came out. Spreads collapsed literally overnight, and the Justice Department and class action lawyers extracted a consent decree and a $1 billion settlement a few years later.

The Forbes article underscores that the Madoff firm had a seat at the table of the self-regulatory organizations that made and enforced the policies and rules from which the firm stood to benefit. From what I gather in various news articles, prospective investors unfortunately took the leadership roles of Bernard Madoff and his family at Nasdaq and NASD as qualifying credentials for the firm as an investment manager, not warning signs or conflicts of interest that needed to be vigorously overseen.

Gaming in Dark Pools (MarketBeat) Excerpt: The rapid evolution of modern markets has caught securities regulators off guard in many instances this year, and they may be overlooking the scope of another problem in the rapidly growing alternative stock exchanges known as dark pools. One hedge fund manager says the only thing stopping him gouging clients of dark pools is his lawyer and his scruples. “It’s free money,” said Richard Gates, a portfolio chief at money manager TFS Capital. “It’s a neat inefficiency in the marketplace, and dark pools are growing tremendously in size.”

I take the MarketBeat post as a sign that the press is now going to be looking critically at little-noticed aspects of the markets, searching for nooks and crannies where the Next Big Problem might be brewing. That examination should be healthy for the development of markets and the protection of investors.

As the post points out, markets indeed have evolved rapidly. Dark pools are not the only such development. For example, internalized orders printed on the Finra-Nasdaq trade-reporting facility now account for more trading in NYSE-listed issues than Nasdaq does. Is that what policy makers intended when designing today’s National Market System? Are such developments getting the appropriate level of regulatory attention, given their size and growth?

I don’t know the answers, but I hope we’re asking the right questions. There have been bigger changes in our markets in the last 10 years than in the previous 200 combined. Are we looking closely enough at the net effects? Conversely, are we stepping back far enough to take in what we’ve collectively created?

I’ll try to mine these topics further. In the meantime, your thoughts are welcome in the comment box below.

PS — I’m taking off “the rest of the year” so posting here probably will be light until I get back on Friday, 2 Jan., 2009. Happy New Year to all. May 2009 bring peace to us all, and a little prosperity might be kind of nice, too.

The Big Options Board (MarketBeat) Excerpt:

The floor of the New York Stock Exchange is undergoing a massive transformation that will not only add more people to the floor for the first time in years, but also give it far greater market share in an area that has been skyrocketing – options.

While trading volumes at the NYSE have never been higher, especially during the worst of the 2008 slump, floor personnel has been shrinking for the greater part of the last decade. About five years ago, there were about 3,000 traders and staff on the floor, compared with just 1,200 at the beginning of 2008.

But in the past month, 70 traders have joined the equities trading operation of the NYSE from the recently purchased American Stock Exchange, with more than 300 options traders scheduled to move into a redesigned art trading room on the floor of the NYSE on Feb. 9.

The NYSE and Amex will immediately move from the fourth- and fifth-largest options volume exchanges into the top three, and closer to the Chicago Board Options Exchange and International Securities Exchange than they have ever been.

Happy Friday, folks. On Wednesday I promised to post any links to the traditional singing of “Wait Till The Sun Shines, Nellie,” and my colleague Daniel Labovitz e-mailed me about this NPR report, which includes audio of the song as well as an interview with Ted Weisberg, president of Seaport Securities. Enjoy!

On Wall Street, Christmas Tradition Gives Hope (NPR.org)

PS — I see that the official name of the song is as I have it above, not the more gramatically correct “Wait ‘Til the Sun Shines, Nellie” that I had on Wednesday. Till intsead of ’til? Hey, give ‘em a break, it was 1906.

A Christmas-Eve linkstocking full of news, and not a lump of coal in the bunch.

Regulators Back System to Clear Credit Swaps (WSJ.com)
The SEC gave exemptive relief for NYSE Euronext and our partner LCH.Clearnet Group to clear credit-default swaps in the U.S. “The approval is a first step toward providing greater oversight to the $54 trillion market, which has operated unregulated while its growth has exploded over the past decade. Congress is expected to take up the issue next year as it sorts out a broader review of financial-market oversight. Approving new platforms to process CDSs is part of an effort to reduce risk in a market blamed for exacerbating the financial crisis,” the Journal says.
Here’s our press release on it.

With IPOs at lowest level since 1977, firms run out of options (USAToday.com)
This article goes beyond the numbers and brings to life the effects of the dearth of initial public offerings on the viability of young companies; the creation of jobs; and the allocation of venture capital.

Technical Problems Halt Electronic Trading at CME (MarketBeat)
“Interest rate traders said open-outcry trading functioned as usual on CME Group’s trading floor, located at the Chicago Board of Trade.”
When the machines go down, traders keep on keepin’ on.

Internet Overtakes Newspapers as News Source (PewResearch.org)
But what is the main source of news on the Internet? Umm…err…newspapers.
And on a related note:
Online v. print reading: which one makes us smarter? (SciAm.com)
I think you can guess the answer.

Last but not least: If one of the networks puts up a link to the NYSE Trading Floor Members singing the traditional “Wait ‘Til the Sun Shines, Nellie,” this morning, I’ll update this post with the link. It’s Christmas Eve, after all. I’m a sucker for the sentimental, and the optimistic. In the meantime here’s a great recording of the pop standard, circa 1906 and complete with 78-RPM vinyl scratchiness. Happy holidays to all, and to all a good 1 p.m. close today.

“In elevating to a level of demiworship people with big bucks, we have been destroying the values of our future generation. We need a total rethinking of who the heroes are, who the role models are, who we should be honoring.”
– Rabbi Benjamin Blech, professor of philosophy of law at Yeshiva University, on the downfall of Bernard Madoff (NYTimes.com)

First and foremost, a reminder: NYSE has a 1 p.m. close tomorrow, 24 Dec. ; is closed on 25 Dec., of course; and is open for regular hours on Friday, 26 Dec. and Wednesday, Dec. 31. If, over the course of the holidays, you hit the egg nog a little too hard and lose track of all this stuff, here’s the calendar for all NYSE Euronext markets. And happy holidays to you and yours, my friends.

A few links on this tepid Tuesday; first, for those who have been looking for research on the impact of uptick rule’s repeal, here you go:

Unshackling Short Sellers: The Repeal of the Uptick Rule; Excerpt from the abstract of this new paper by Ekkehart Boehmer of Texas A&M, Charles Jones of Columbia Business School and Xiaoyan Zhang of Cornell:
…Repeal [of the “uptick rule”] causes market liquidity to worsen slightly, and short sellers on average become less contrarian. Compared to the pilot program, complete repeal makes index arbitrage and other program (multiple-stock) shorting strategies easier to implement, and this could explain the post-repeal changes in seemingly unaffected pilot stocks. We find no evidence that repeal of the uptick rule destabilized prices or otherwise contributed to the bout of volatility experienced by U.S. stocks in late July and early August 2007.

2008 Lookback: Where to Start? (MarketBeat) Excerpt:
MarketBeat will be looking back on the year in a series of posts over the next several days, but in the ords of Inigo Montoya, “Let me explain. No, there is too much. Let me sum up.” A year like this needs a summary, and so we begin with our list of the overaching themes of the year:
1. Getting Punched in the Gut on a Daily Basis…

I think that No. 1 kind of sums up the year pretty nicely all by itself, don’t you?
Also, props on the “Princess Bride” reference.

No News Here: Forrester Says Consumers Don’t Trust Corporate Blogs (DebbieWeil.com) Excerpt:
Forrester’s new report, Time to Rethink Your Corporate Blogging Ideas, says that only 16% of consumers trust company blogs and that they rank dead last in terms of marketing channels…
Yep. That’s below consumers’ trust level in promotional emails, direct mail (!), and online classifieds. Why? Well, the answer is obvious.
Many corporate blogs are A. boring and B. not credible. They’re written in corporate speak…

Boring? Not credible? Corporate speak? Surely they’re not lumping Exchanges into that, right?

I said, right? Hello?

[Sound of crickets chirping]

So much for my comment a few weeks ago that “blogging probably has a higher credibility factor than other types of corporate communication (though that probably isn’t a high bar to clear).” Looks like we have a lot of work to do.

NYSE Euronext’s Liffe launches CDS clearing unit (Reuters.com) Excerpt:
Derivatives business Liffe on Monday became the first exchange to offer clearing of credit default swaps index trading in Europe as regulators push to improve stability in the CDS market.
The CDS clearing offered via Liffe’s Bclear — owned by NYSE Euronext and LCH. Clearnet Ltd — will initially cover the Markit iTraxx Europe, Market iTraxx Crossover and Markit iTraxx Hi-Vol indices. “This important launch delivers one of the highest financial priorities for governments and regulators globally,” Duncan Niederauer, Chief Executive Officer of NYSE Euronext, said in a statement.

First to market — nicely done, my LICs (Liffe-innovating colleagues). Here’s our press release on the same subject.

I have a day off today, so posting will probably be quiet here. Have a good Monday.

On This Day in 2002 (NYTimes.com), Joe Strummer of the Clash died at age 50, way too young.

We’ve postponed the rollout of enhancements to the handling of Market-on-Close and Limit-on-Close orders that was scheduled to begin this Monday, 22 Dec. 2008. Here’s the text of our notice, which will be posted shortly on our Trader Updates page:

“The planned roll out of the previously announced enhancements to the handling of Market-on-Close and Limit-on-Close orders that was scheduled to begin this Monday, December 22, 2008 has been postponed to a later date. The Exchange has decided to delay the introduction of the order enhancement based on feedback we have received from our clients over the last week. The specific changes were originally announced in a detailed client communication on December 12, 2008. Additionally, the NYSE will not disable the current optional MOC and LOC blocks that members have previously requested to be added to their individual mnemonics, as originally planned for this weekend.
The NYSE will announce new, simplified closing procedures in January 2009 in a separate client communication, and will couple the new systems blocks with those procedures at that time. Please contact your Relationship Manager if you have any questions regarding this notice.

Here are some items I’ve been meaning to post:

Arca Adds Depth-of-Book Routing (TradersMagazine.com)

Word for Word (TradersMagazine.com) — Our Joe Mecane talks about the problems surrounding the short-sale ban in September and October.

NYSE SLP Program Kicks Off (TradersMagazine.com)

2008 Review: NYSE Fights Back with Designated Market Makers (TradersMagazine.com) Just a quibble on this one: SLPs are not market makers, so we’re moving to a multiple-liquidity-provider model, not a multiple-market-maker model.

UPDATE 3-Nasdaq to extend listing-rule suspension to April (Reuters.com) Why stop at April? How about extending it “until the next bubble kicks in”?

At 5:45 into this video, Jay Leno names the Ponzi scheme. Hey, he said it –I didn’t.

Bonus link: News You Can Lose (NewYorker.com) James Surowicki examines the state of newspaper economics and says we’ve been getting newspapers’ content on the cheap via the Web; he adds, “Soon enough, we’re going to start getting what we pay for, and we may find out just how little that is.”

In case you missed it: today is the quarterly expiration day for stock and index options and futures, which has been known to drive a lot of trading activity. Here’s our memo about it.

If you need a little pick-me-up this morning, take a few minutes to read this humorous piece in today’s New York Times about the flaws and beauties of “It’s A Wonderful Life.” My take is that while Pottersville seemed like a fun place to visit, I probably would prefer to live in stodgy ol’ Bedford Falls. What about you?

Have a good Friday. The day job has been a little overwhelming this week, but will try to post some more later.

Today in NYSE History (NYSE.com)
19 Dec. 1927– The Dow Jones Industrial Average closed above 200 for the first time.

Two notable articles on TradersMagazine.com:

Fewer Block Shares Traded in Networks During Big Downturn Excerpt:
Liquidnet, Pipeline and ITG collectively averaged .67 percent of overall market volume in September and October, against 1.1 percent they averaged from January through August, according to dark pool volume estimates the consultancy TABB Group supplied Traders Magazine.
Collectively, their volume dropped to 70.8 million shares per day, single-counted, in September and October. This compared to 75.7 million shares a day, single-counted, they traded the prior eight months, TABB data showed.

Meanwhile, NYSE in October executed 671 million shares in block-sized trades (10,000 shares or more), or 40 percent of all block trades in NYSE-listed stocks. Of these, 300 million shares were handled by NYSE Trading Floor Brokers, either using an algo or otherwise using their hand-held order-management-system, or crossing the shares physically. Blocks remain a point of differentiation for our market.

Volatile Markets Put Sales Traders in Demand Excerpt:
High-touch is making a comeback. According to traders and analysts, the buyside is doing less trading by itself and leaving more of its orders with brokerage sales traders.
“The buyside wants that human interaction, that dialogue, especially in these times where any little bit of color can be beneficial and can help you implement the trade better,” Joseph Mazzella, who’s in charge of listed block trading at Knight Equity Markets, told Traders Magazine. “We’ve seen the pendulum swing from the low-touch side and come back to a more neutral stance.”

Wow — human interaction, dialogue and a bit of color can help you get a better trade? Who knew?