How a Floor Broker Can Help You

Longtime NYSE member Bernie McSherry has a lengthy, terrific video interview on Forbes.com. You have to sit through two commercials and a Steve Forbes tax editorial before getting to the interview, but it's worth it.

Bernie talks about high-touch trading, the uptick rule, Crash of '87, credit-default-swap trading and regulation, and more. One particularly relevant excerpt

STEVE FORBES: Now, you've made the observation that on heavily traded stocks like a Microsoft, you really may not need human beings, that the electronics can work perfectly well, but in less traded stocks, there is a role to play. Do you think we need perhaps a new exchange for smaller stocks and just have a one-tier, two-tier, four-tier kind of exchange? One electronic, one semi-human, one fully human?

BERNIE MCSHERRY: Yes, I think something like that is we're in the process of evolving towards that now. The big names that are very liquid, there's not a lot of money that a broker can save for you. You know, if something is offered at 30 cents in very large size, I'm probably going to pay 30 cents when I get there and I'm not going to really make a difference. ButSTEVE FORBES: And is that something recognized by regulators, something to be encouraged? Or are they just sort of taking hands off and watching it all unfold?

BERNIE MCSHERRY: Well, I think initially there was a bit of a bias against the exchange in the terms of I guess the exchange was probably not embracing change for quite some time.

STEVE FORBES: Right.

BERNIE MCSHERRY: And the regulators wanted to nudge them along and were not really listening to their arguments very well. Now that we've come through a particularly volatile period, I think there's some recognition that it's a good idea to have a central market of some sort. It's easier to regulate. It's better pricing. And we've had a proliferation of market centers. There are probably 30 or so out there now. And it's very difficult for people to trade large blocks of stock because it's so fragmented. So I think the momentum is swinging back a little bit, and we'll see. But I think the regulators would probably prefer to see a little more consolidation.

STEVE FORBES: And in terms of trading large blocks, some advances have been made. Maybe you can touch on those, or at least changes, whether you call them advances or not depends on your perspective, but changes. And what more changes do you think? You mentioned block traders don't want to have their hands revealed. And they're always trying to find ways, dark pools and the like, to figure out ways to have their strategy unfold without people seeing it unfold, in effect.

BERNIE MCSHERRY: Right. Well, that's one of the benefits of human trading. People develop relationships over time, colleagues, competitors. You have a reputational effect when you walk into a crowd. And if you squander that, you're going to have a hard time getting information.

Brokers used to do a mating dance. They'd walk into the crowd and say, "Well, I'm a buyer." And then somebody would respond and say, "Well, I'm a pretty good seller." And then the buyer would respond by saying, "Well, I have a fairly large buy order." And then the seller would say, "You know, I'm not afraid of a size bid." And in a matter of seconds, they could print a million shares or so on the tape, get it traded at a fair price for everybody in a way that didn't reveal their hands to people who were outside of that actual trade.

In an electronic system, if you try to put a bid like that into a system, everybody in the world sees it. They run in front of it and drive the price up or down in front of you. So they haven't really been able to replicate that exactly. There are some efforts now. The New York Block Exchange is an example.

There are a few other systems that are trying to come up with a way of replicating that dynamic. But it's very difficult when somebody is involved anonymously with it because there's no real penalty to be paid if you don't behave well.

STEVE FORBES: So there's no real way yet to chop up a block and have it done in a way where people aren't figured out what's going on?

BERNIE MCSHERRY: Right. People are slicing them up and they're getting them into the market. But it takes a lot longer time. The price impact is far more uncertain. And there are some systems that have been developed to bring buyers and sellers together. But they are not as effective as the old way just yet. But people are working on it. I have no doubt that technology will catch up at some point.