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Robert Sales
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All Aboard: Fidelity, Schwab, DLJ and Spear Leeds Form ECN Alliance; Agenda Includes After-Hours Trading

The yet-to-be-named ECN will be registered as a broker/dealer and is scheduled to go live by September.

In a move that could eventually stimulate consolidation in the equity trade matching system market, Fidelity Investments, Charles Schwab Corp., Donaldson Lufkin and Jenrette (DLJ) and Spear Leeds and Kellogg last week agreed to jointly launch a new electronic communications network (ECN). The yet-to-be-named ECN--which will be registered as a broker/dealer and is scheduled to go live by September--could potentially rake in significant retail order flow from the online brokerage units of Fidelity, Schwab and DLJ. Moreover, possibly as soon as October, the ECN could serve as the first-ever after-hours trading mechanism for the partners' retail investors.

With one notable exception, the ECN will use the same technology and operate in the same manner as Redibook, Spear Leeds' existing ECN. The exception is that the new system, unlike Redibook, will have electronic links to the online trading offerings of Fidelity, Schwab and DLJ. Currently, Redibook is targeted primarily to professional traders and buy-side institutional investors. However, the new ECN--via the online trading system interfaces--will have access to a huge pool of individual investor orders.

Lon Gorman, president of Schwab Capital Markets and Trading, says that the joint ECN may appeal to "large institutions" that want to tap into a liquid equity matching system. However, noting that all four of the partners are Nasdaq market makers, Gorman says that he expects most of the new ECN's volume will stem form retail orders. "Primarily, the market making that the partners do revolves around retail investing. So we would imagine that...the order flow that would be coming to this ECN would be mostly of the retail nature," he says.

Before the joint ECN goes live, the partners have to obtain a broker/dealer license and get clearance from both the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD) to launch the new entity. Gorman does not expect regulatory approval to be a stumbling block, but says the partners still have some work to do to determine "what kinds of orders" will be eligible to be sent to the ECN.

Regardless of what the partners conclude on the order eligibility front, it is certain that the new ECN will experience a volume boom. Last month, Redibook traded a daily average of 21 million shares. Gorman declines to predict the amount of daily volume of the renovated version of Redibook will generate, but with the aid of online trading order flow, it wouldn't be a bad bet to say the renovated ECN will pose a threat to the thrones of Reuters' Instinet--the largest institutional investor-oriented ECN--and Datek Online Holding Corp.'s Island--the biggest ECN for retail investors.

Moreover, since there will probably be only a handful of matching systems gobbling up order flow in the near future, the new Redibook could spell the beginning of the end for some of the existing smaller ECNs--which need liquidity to survive.

Just as significantly, the joint ECN could for the first time allow retail customers of DLJ, Fidelity and Schwab to execute trades after normal stock market hours. In the past, those customers have not had a mechanism for trading NYSE-listed stocks and Nasdaq Stock Market issues after those markets closed. Traditionally, that privilege has been reserved for institutional investors who trade on systems like Instinet. And while the NYSE and Nasdaq have talked about launching after-hours trading sessions, they both recently declared their intention to wait until next year to go live with an extended-hours format.

The new ECN consortium, however, could present a solution to retail investors' after-hours dilemma in the near future. Redibook currently runs from 8 a.m. to 5:15 p.m. EST. But Schwab's Gorman--while cautioning that the partners are still evaluating after-hours issues--says that Spear Leads could provided extended-hours capabilities as early as October. "This is a service we intend to provide, assuming that the regulatory framework allows it.... and that there is a liquid environment that would allow our customers to experience a good execution," he says.

Since the stock market in California essentially closes at 1 p.m., the San Francisco-based Schwab likely has the most interest of any of the partners to provide its customers with an after-hours trading mechanism. What's more, based on the results of Schwab customer surveys, Gorman estimates that 40% of customers who give Schwab orders after hours would "actually trade after hours." Not surprisingly, how quickly the joint ECN moves to an extended-hours format will also hinge on the steps rival ECNs take. "I will tell you that if there is any ECN that is up and providing the after-hours service, we intend to compete," Gorman says.

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