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Techie Upstart Taking on Stock Markets

2007-06-06 10:52:40

March 8, 2007 7:17 PM ET

KANSAS CITY, Mo. (AP) - As the markets dropped sharply last week, sending

volume soaring and backing up trades handled by the New York Stock Exchange, at

least one stock market player was resting easy.

Bats Trading, an upstart electronic trading system hundreds of miles away in

Kansas City, said it handled the volatility with none of the glitches that

others did.

Bats has quickly become the third-largest stock trader by volume, trailing only

the NYSE and Nasdaq Stock Market, thanks to its technology and aggressive

pricing. And with new Securities and Exchange Commission regulations designed

to ensure that trades are routed to the market that offers the best price, Bats

is poised to pull more business away from the NYSE and Nasdaq.

Since founder Dave Cummings set out last year to challenge the two exchanges,

volume on his electronic trading platform regularly tops 300 million shares per

day, or about 15 percent of what is traded on Nasdaq. Cummings predicts that

total will reach one billion shares a day by the end of the year.

Recently, the company began the paperwork to become a legitimate stock

exchange, a process that could take several years but would level the

regulatory playing field with the NYSE and Nasdaq.

"We've just been able to execute our plan," Cummings said. "We're very good at

being nimble entrepreneurs."

Cummings is a 37-year-old self-styled "computer geek," who was born just

outside of Kansas City. He graduated early from Purdue University with degrees

in computer and electrical engineering, then went to work for medical software

company Cerner Corp.

In 1995 he ventured into the pits at the Kansas City Board of Trade, where he

designed a computer system that would automatically do the work of a pit

trader, first trading wheat futures and later stocks.

That computer system evolved into Tradebot Systems Inc., which like Bats is

headquartered in Kansas City, Mo., but houses its computer systems in a suburb

of New York City, close to Wall Street.

Tradebot took advantage of electronic communications networks like Archipelago,

INET and Brut to quickly execute trades. Unlike traditional exchanges, which

act as intermediaries to connect buyers and sellers, ECNs automatically match

buy and sell orders at specified prices.

But over the past couple of years, the NYSE and Nasdaq aggressively bought out

the ECNs that offered the greatest competition. Cummings opened his own ECN --

Better Alternative Trading System, or Bats Trading -- just over a year ago,

with Tradebot one of its first customers.

"I like to move very quickly," Cummings said. "I'm known to be very impatient.

I lay out a goal, I break down that goal into steps that can be implemented,

and start moving. Pretty soon you're across the room and you didn't realize

it."

Cummings hopes to capitalize on the trend toward electronic trading that has

already led the NYSE to begin phasing out about 20 percent of its floor space.

The NYSE and Nasdaq aren't the only stock exchanges facing new competition,

though. Seven investment banks are banding together to create a secondary

trading platform in Europe called Project Turquoise, which could eventually

rival the London Stock Exchange.

But Larry Tabb of The TABB Group, a New York-based consulting firm, said two

things have allowed Bats to thrive where others have not.

First, Cummings made arrangements with several major electronic marketing firms

like Getco LLC that generate millions of trades without people being involved.

That created the volume that attracts other brokers, who can then buy and sell

shares more efficiently.

"Once you get a certain amount of volume, others want to be there," Tabb said.

"You prime the pump, so to speak."

Second, the company has only a couple dozen people in modest offices. Cummings

has spent less than $20 million so far, and as a private company, does not have

to answer to public shareholders. That has allowed him to offer a pricing

structure that includes low base trading fees that are supplemented with large

rebates for volume traders.

"If you went to the New York Stock Exchange, they have this imposing structure

on Broad and Wall. You go to Bats, they're on the second floor of a Kansas City

strip mall," Tabb said. "They have a very different cost structure."

While Bats' final price of two cents for every 100 shares traded usually

undercuts the NYSE and Nasdaq, a special in January offered a rebate larger

than the base price, essentially paying broker-dealers to use the Bats system.

The company lost about $6 million, but attracted more trading to the platform.

Even after prices returned to normal, volume has hovered around 300 million

shares per day. A single-day record of 399.9 million shares moved on Feb. 27,

the day the Dow Jones industrial average plunged 546 points before ending the

day down 416, the largest one-day decline since markets reopened after the

Sept. 11 attacks.

"From a strict client perspective, Dave is essentially a very fast,

technologically efficient system," said Jamie Selway of New York-based White

Cap Trading LLC, which uses the Bats system. "It's a very stripped down,

efficient electronic trading vehicle. And the price is exactly right."

Several broker-dealers have bought into the company, including Lehman Brothers

Holdings Inc. and Credit Suisse Group, who trade millions of shares each day in

Nasdaq-listed volume and NYSE Group-listed shares.

On Wednesday, Merrill Lynch & Co. added its name to the list, purchasing a

minority stake for an undisclosed sum.

"They're going to be one of the winners and the brokers are realigning to place

bets on the winner," Tabb said, "and on the crazy guy who's willing to take on

Nasdaq, and eventually the New York as well."

Rich Adamonis, a spokesman for the NYSE, said the company does not typically

comment on competitors. But he said Bats has been surprisingly successful, and

that the NYSE "welcomes competition in the market place."

Nasdaq spokeswoman Bethany Sherman also declined to address Bats specifically,

but pointed out a recent earnings call in which chief executive Bob Greifeld

was asked to address the upstart competitor.

"We respect them," said Greifeld, adding that he does not believe the Bats

pricing structure will allow for long-term growth. "The fact is that it's not

in the interest of anybody in the space to have exchanges, ECNs, that are not

sustainable."

Cummings insists that he is not out only to make a profit, and that he

genuinely cares about competition in the market. But he is willing to fight for

his share, even if it means pointed attacks at Nasdaq in an e-mail

correspondence with customers and street-wide observers.

Recently, Cummings said Nasdaq's failed attempt to buy the London Stock

Exchange would be the "biggest financial blunder of 2007." Another e-mail

claimed "Nasdaq seems to be getting very close to a total schizophrenic

meltdown," and that "they consistently do everything possible to stomp Bats out

of existence. (But) everything they do seems to backfire."

The back-and-forth has caused many market observers to cringe.

"People are pretty amazed at how much he's been able to accomplish," said Sang

Lee, managing partner of Aite Group, a Boston-based financial services research

firm. "They may not say it publicly, but I would bet they are concerned. I

think they should be concerned."

Said Selway: "He's a positive force for competition, but I think it has gotten

pretty personal."

Cummings chuckles at the notion that his upstart company is ruffling the

feathers of Nasdaq and the NYSE. He says he has a 30-year plan, and if he's

roused up this much controversy in a little more than year, who knows what

comes next?

"I got into this market to make $100,000 a year and feed my family and to allow

my wife to stay home with the kids," Cummings said. "I never in my wildest

dreams thought we'd be here at the center of the U.S. equities market."

___

On the Net:

Bats Trading: http://www.Batstrading.com

New York Stock Exchange: http://www.nyse.com

Nasdaq: http://www.nasdaq.com

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