Trading places
The Star-Ledger - October 19, 2003
The Star-Ledger Archive COPYRIGHT © The Star-Ledger 2003
Date: 2003/10/19 Sunday Page: 001 Section: BUSINESS Edition: FINAL Size: 1751 words
CEO of electronic stock trading venture brings a diverse, eclectic background to debate about where the markets are going
By SAM ALI STAR-LEDGER STAFF
When the history of the latest tremors shaking Wall Street is written, one of its towering figures may very well be the lanky 6-foot-6-inch Edward Nicoll, his arms extended like wings in midconversation, like a condor ready to take flight.
Nicoll spent the past 30 years building alternatives to the Wall Street trading establishment and creating systems that have forced stock markets to change the way they operate.
Long before the Big Board started investigating whether specialist firms improperly profited off customer orders, Nicoll - first as chairman of Island during 1999 and now as the head of Instinet Group, after the merger of the two companies during 2002 - was a fierce and vocal critic of the New York Stock Exchange's floor-trading model and its specialists.
And he has led the charge to modernize U.S. trading by knocking down outdated regulatory barriers that, so far, have shielded the NYSE from competition.
"A positive effect of the current scandal at the NYSE is that it sweeps away old assumptions and allows people who otherwise would not have considered market-structure issues to think anew, to consider alternatives without old biases for the status quo," Nicoll said during an interview in his ninth-floor office in the flashy Reuters building at 3 Times Square. "The status quo is now seen as broken."
Like many critics of the Big Board, Nicoll is hoping the latest investigation into specialist-trading practices will help lead to meaningful change and open up trading of listed stocks to electronic communication networks, such as Instinet. ECNs, which use computers to match customer buy and sell orders, have modernized trading on the Nasdaq market and driven down costs for investors.
Just last week, Instinet started running a series of ads and billboards attacking the NYSE's practices.
The outrage is clearly spreading. Recently, a big NYSE customer, mutual fund company Fidelity Investments, joined the growing chorus calling for the abolition of its 211-year-old floor trading system, which relies on human beings.
For Nicoll, the public flap about former NYSE Chairman Richard Grasso's $140 million retirement package is just a sideshow.
The real root of the problem is the quarter-century-old "trade-through rule," which he considers a major obstacle preventing ECNs and regular investors from vigorously competing on a level playing field with the NYSE.
Under the rules, if an ECN, like Instinet, wants to execute a trade of a NYSE stock at a price that is inferior to a latest price on the Big Board, it must first send down a request to the human specialist on the trading floor. The trade-through rule allows the specialist 30 seconds to respond to the request or ignore it. ECNs complain the NYSE ignores requests all the time.
The NYSE has long argued its strength - the reason it has been able to successfully hold onto 80 percent of listed business done on its floor - comes from posting the best prices anywhere for listed stocks 94 percent of the time.
Nicoll, however, said the rule is antiquated, often fails to best serve customers in today's sub-second electronic trading world and limits investor choice.
"We're not asking for anybody to destroy the NYSE," Nicoll said. "We're asking for our prices, our market, to be published side by side with New York and let people choose whether they want an electronic market or a floor-based market."
While this may sound like heresy, it certainly wouldn't be the first time a seemingly insurmountable barrier on Wall Street was toppled. Nor would it be the first time Nicoll has been on the front lines, making things happen.
"If you look at all genius-in-the-works, they are often looked at as heretics," said Cory Booker, a former city councilman in Newark's Central Ward and a fellow Yale Law School classmate. "Eventually, they are seen as great innovators, and I think Ed is one of those people. He's viewed as threatening at first, but then you realize, he's on the vanguard of change."
STARTING LINE The problem with telling Nicoll's story is knowing exactly where to push the start button.
Was it when he borrowed $3,000 to help start Waterhouse Investor Services during 1978, a firm that would later become TD Waterhouse, the second-largest discount brokerage in the world? Or perhaps, his disastrous two-year stint as a sheep farmer in northwestern Pennsylvania? Or maybe the part when at the age of 40, the Montclair resident became the first person in modern history to attend Yale Law School without ever having gone to college?
In a world of predictable people, this Wall Street executive has lived many lives.
Nicoll was raised by a single mom in Paterson after his father abandoned the family when Nicoll was just a toddler.
During his youth, he showed little ambition. He said he was rebellious, a classic underachiever and bona fide street punk, even though by others' accounts, he possessed the brilliant mind of a scholar. After graduating from Passaic High School with mediocre grades, he was supposed to enter a small college. Instead the 18-year-old Jersey boy packed his bags and left to run a sheep farm in rural Pennsylvania.
"It was an abject failure," he said. "I lost what little money I risked on it. It disabused me of any romantic notion I had of being a farmer."
SHEEP FARMING What sheep farming did do, however, was spark an interest in commodities and trading, which eventually landed him his first job at a brokerage firm in Pittsburgh.
By 1976, Nicoll, then 23, was in New York City working at Reynolds Securities, where he quickly struck up a friendship with another broker at the firm, Larry Waterhouse, who was 17 years his senior.
Just one year earlier, May 1, 1975 - a day popularly referred to as May Day on Wall Street - the world of investing was turned upside down when the SEC effectively ended fixed commissions.
Brokerage fees were fully negotiable, and Nicoll and Waterhouse, sensing opportunity, quickly pounced. The pair founded one of the first discount brokerages in the country, Waterhouse Investment Services, during 1978.
"Larry owned most of it. I was only able to invest a small amount. I borrowed $3,000 on my credit card, but that turned into a lot of money and I became wealthier than I ever dreamed I could become," said Nicoll, who still lives in the same modest Montclair home he and his wife, Helen, a former dancer with the New York-based Murray Louis Dance Company, purchased when married 22 years ago.
BACK TO SCHOOL Nicoll's decision to go back to school during 1994, came following the death of his mother, he said.
At Yale Law, his fellow classmates were in awe of Nicoll.
"What everyone knew at the time was he had made a fortune in business and had come to Yale for a purely intellectual experience," said Mark Gerson, chief executive of Gerson Lehrman Group, a New York-based investment research firm and one of Nicoll's classmates at Yale. "The word was out that he was absolutely brilliant."
Gerson said he learned everything he knows about business from Nicoll. "I got my business education in large part from talking to Ed at Yale," he said.
Nicoll later promised Gerson he would invest in any business venture he pursued.
"You don't care what it is?" Gerson recalls asking Nicoll.
The answer was no, because, according to Nicoll, "you invest in people, not ideas," said Gerson, noting that today, Nicoll remains a director on Gerson's board.
Nicoll also invested in Booker, serving as his campaign finance director when the Newark resident successfully ran for a seat on the city council in Newark's Central Ward during 1998.
"Ed Nicoll is a guy who wanted to make a difference and I think he is driven by that," Booker said.
SELLING OPPORTUNITY While Nicoll was at Yale Law during 1996, he and Waterhouse decided to sell Waterhouse Securities to Toronto-Dominion Bank. That same year, Wall Street was once again in the throes of crisis and the sense of revolutionary change was palpable in the air.
The Justice Department and the SEC had accused market makers on Nasdaq of colluding to keep the spreads between stock prices artificially high.
Under terms of the settlement, the SEC during 1997 imposed order-handling rules that required dealers to publicize customer orders whose prices were better then their own.
That rule - which granted nimble ECNs Instinet and Island the right to link their computers directly to Nasdaq and post their customers orders - fostered the growth of the ECN industry.
Again, Nicoll smelled opportunity.
During 1998, the freshly-minted Yale Law graduate came to the rescue of troubled discount broker Datek Online, when the company was under investigation by federal authorities for trading and lending violations.
"I bought a big chunk of Datek and one reason I was interested in Datek was this other little company inside Datek called Island," he said. "I found the whole thing intriguing."
It was a good call.
During his tenure, Datek cleaned up its act, eventually becoming the fourth-largest discount brokerage in the country, before Nicoll sold it to Omaha-based Ameritrade Holding during 2002.
TIME TO THRIVE At the same time, the SEC's order-handling rules enabled ECNs, including Island, to thrive and make tremendous headway in the Nasdaq market, reaching more than 170 billion shares by the end of 2001, said Sang Lee, the manager of securities and investments at Celent Communications, a Boston-based research firm.
That translates into about 37 percent market share within Nasdaq for the ECNs, Lee said.
ECNs account for only 9 percent of the listed business on the NYSE.
Whether regulators decide to treat the NYSE the same way they treated Nasdaq during 1996 remains to be seen.
One thing is clear, however:
Instinet, which has been struggling to deal with increased competition and a soft market for stock trading since its merger with Island during 2002, stands to gain in a big way if the NYSE barriers to competition come crashing down.
And if the do, Nicoll will surely be on the cleanup crew.
"He's only 50 years old and I believe his greatest days are ahead of him," Booker said.