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An Industry in Denial

Industry participants believe the costs of Reg NMS will be someone else's problem, but investors surely will pay.

Reg NMS is set to change the foundation of the securities industry -- that much is agreed upon. Most people also agree that this change represents a major industrywide spend. But on whose shoulders that expense will fall remains largely up in the air, and most are saying -- and hoping -- that the burden doesn't land on them.

For the most part, the buy side is waiting until Reg NMS is finalized before making any investments in technology to support the new market structure. While Reg NMS may necessitate the rethinking of investment strategies, some believe buy-side firms are not going to be pained by technology expenses. "The buy side doesn't have the problem," says Joe Gawronski, chief operating officer at New York-based Rosenblatt Securities. "Clearly, it's whom they send [their orders] to that bears the expense."

But the buy side still may feel the effects of Reg NMS as a result of how it will change the broker-dealer business, argues Larry Tabb, CEO of Westborough, Mass.-based TABB Group. "This will fall very hard on the buy side," Tabb says. "It's going to be very difficult for the buy side to execute without a major bulge-bracket broker. I think it's going to be very difficult for the money manager to have confidence that the smaller sell-side firms will be able to get them best execution," he explains.

The burdens of best execution and avoiding latency, and the technology costs associated with addressing those issues, may redefine what it means to be a small sell-side firm. "It basically gets them out of the execution business," says Tabb, who speculates that to stay viable, small broker-dealers will have to move into offering research and service. "The order flow will move to bigger brokers," he adds.

And the buy side will feel the pain of losing the specialist boutique, Tabb asserts. In the current market, there clearly is value to be had in specialist execution and service. Moving special orders to bulge-bracket firms, a block order of a small-cap stock, for example, may degrade quality of service and increase market impact, and has the potential to result in an adverse effect on the buy side's alternative trading strategies, Tabb explains.

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