Another Exchange for All

By Reporter Karla L. Yeh

Direct Edge Vs. the Three Musketeer Exchanges: Another Exchange for All

Chief Executive Officer Bill O'Brien tells Markets Media that Direct Edge stays focused on value and innovation while waiting to become an exchange.

By Reporter Karla L. Yeh

JRSEY CITY, N.J. _ Direct Edge ECN LLC is to the nation's three exchanges as d'Artagnan is to the Three Musketeers. The electronic communication network claims to have all the credentials to join the ranks the nation's three biggest exchanges: NYSE Euronext, NASDAQ and BATS Trading, which in August won the Securities and Exchange Commission's approval to transform from an ECN to a registered national securities exchange.

Bill O'Brien, chief executive officer of Direct Edge, told Markets Media in July that a formal filing for exchange status was “imminent” and that the company was in the process of drafting two applications. O'Brien said the firm expects to become an exchange by second-quarter 2009, at which time Direct Edge will provide even more options on an international scale.

“Converting to exchange status will lay out our strategy for geographic diversification,” O'Brien said. “It's about continuously growing our core business.”

It's an exciting time for Direct Edge Holdings, the parent company of Direct Edge ECN. In August it signed a definitive agreement with the International Securities Exchange (ISE) to form a single U.S. equities platform. Under the partnership, the ISE Stock Exchange will become a wholly-owned subsidiary of Direct Edge, and ISE will gain an ownership stake in Direct Edge. Through the combination, Direct Edge gains direct access to the National Market System, strengthens its technology and infrastructure and takes a significant step towards meeting the regulatory requirements needed to become an exchange.

“Through this transaction, we will be aligning ourselves with an innovative new leader

whose compelling offering stands out in the highly competitive cash equity space,” Gary Katz, president and CEO of ISE said when the companies announced the partnership Aug. 22. “We have successfully grown the ISE Stock Exchange to the point where it is today, and are confident that this partnership with Direct Edge is the logical next step that will enable us to continue our strong growth in the U.S. equities market.”

Direct Edge didn't always have the edge to attract O'Brien. It failed to impress him as a company searching for its next chief executive officer. In October 2005, Knight Capital Group Inc. acquired Direct Edge ECN and approached O'Brien, who was working as senior vice president at The Nasdaq Stock Market. But from the beginning, O'Brien said he was neither convinced the company was the “right growth opportunity” nor was he “jazzed” about the strategy.

O'Brien joined Nasdaq in September 2004 when the exchange bought Brut LLC, an alternative trading system company, from SunGard Data Systems Inc. for $190 million in cash. O'Brien served as Brut's chief operating officer since 2002 and joined the company as senior vice president and general counsel in 2000. O'Brien, a self-proclaimed “lawyer by trade,” previously worked in Goldman Sachs' and Orrick LLP's legal departments.

His previous experience and fondness for running a small growth company like Brut made him confused about joining a firm like Direct Edge, whose strategy at the time went against conventional wisdom.

O'Brien recalled the “trepidation” he felt when Knight Capital reproached him in 2007 with the same CEO offer.

“I was 80 to 85 percent sure about the decision,” said O'Brien.

But shortly after his decision, O'Brien changed the company's business model, scaled up the infrastructure and made the company “different, better, special.”

“I felt like I knew how to do it all,” he said. “I wasn't a genius. I just added some sweat to the equation.”

Once O'Brien signed on, he realized that focusing on innovation as the “apple” of the Direct Edge space would set his company apart from the Three Musketeer Exchanges, leveraging growth and market share for exchange status.

EDITORS NOTE: Reporter Karla L. Yeh coined the term “Three Musketeer Exchanges” just as BATS Trading joins the Big Three of registered national securities exchanges.

Direct Edge offers its clients marketplace edge from two platforms: Edge X and Edge A. The platforms operate as “virtually consolidated” market centers that charge separate rebate prices for posting and removing liquidity. While Edge A requires no fee to use or introduce liquidity, Edge X offers high rebates and low removal fees for users who post high volume share daily. Users do not incur any incremental cost and are subject to better rates than those of direct market access to exchanges no matter which platform they choose in Direct Edge, according to O'Brien.

“With this model, we can be more things to more people,” he added.

In addition, Direct Edge offers an enhanced liquidity provider program, comprised of 20 independently branded dark pool liquidity broker firms, designed to keep the company connected to “off-grid” liquidity. Through the ELP program, the company has positioned itself between order subscribers and enhanced liquidity providers within displayed and dark venues. According to O'Brien, Direct Edge is the only exchange and ECN that offers “material integration” in which the ELP program and trading platforms inject integrated access into the markets.

“We zig when a lot of our competitors zag.” The company's “zig” focuses on the customers and the value of Direct Edge offerings as priorities, ensuring greater use of its capabilities. As the number of users continues to double each year – Direct Edge reported it handled more than 988 million shares per day in July and experienced a 248 percent increase over the year – O'Brien said his company maintains its “at scale” approach for international expansion. Though the company has plans to move into Europe, Canada, Australia, Japan, Korea and Taiwan, global expansion is not a 2008 initiative for O'Brien.

“We're taking a deliberate approach to expansion opportunity,” he said. “Where it is, I'm not sure yet.”

BATS Trading was the most recent addition to U.S. exchanges after the SEC granted the equities market firm exchange status on Aug. 18. But in the meantime, Direct Edge waits to earn its exchange status among the existing Three Musketeer Exchanges, a move which O'Brien expects will add value to his company's offerings and client demands. Just as the company became the fourth U.S. equity trading venue to surpass 1 billion shares in a day on July 11, O'Brien expects to continue to innovate and begin a new existence as the Fourth Musketeer of U.S. exchanges.

“We are one degree from Kevin Bacon from exchange status,” O'Brien said. “I feel like we're really just getting started.”

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Posted on Sept. 23, 2008