In the past, buy-side firms sent trades to block desks and often received equity research in return. Following the $1.4 billion settlement between regulators and 10 top Wall Street brokerage firms over their equity research practices in 2003, institutional investors cut their use of Wall Street research in favor of either in-house or independent research.
The recently passed Regulation NMS, the Securities and Exchange Commission's market structure rule, also could drive business away from block desks as it puts more emphasis on electronic trading methods, which allow investors to parcel trades.
Reg NMS will amend and extend the trade-through rule. The rule, which now only applies to listed stocks, will be applied to Nasdaq stocks as well. It will require orders that can be automatically executed be routed to the market venue with the best posted price — whether that's the NYSE, the electronic Archipelago Exchange or an alternative trading system or electronic communications network. The rule will take effect June 12, 2006, after a trial phase that will begin April 10, 2006.
Alfred R. Berkeley III is chairman and chief executive officer of Pipeline Trading Systems LLC, New York, an alternative trading system that facilitates block trading by institutions and brokers. He said Reg NMS has highlighted the issue of declining use of block desks.
"Reg NMS is trying to solve the same problem we are, but it's doing it in a way that will force order size to be even smaller," he said, explaining that while the regulation will encourage quicker trading, it does nothing to encourage participants to put up larger orders. On Pipeline, where the "book" of orders is hidden so buyers and sellers meet anonymously, the minimum order size is 25,000 shares. He said the average block that trades on Pipeline is about 50,000 shares.
But some buy-side traders disagree.
"With the passage of Reg NMS, this is a topic that's in the forefront," said Mr. Sachs, referring to block trading. "We certainly have the camp that says the block trader's a dying breed, much like the (NYSE) floor trader, but that couldn't be further from the truth in my mind."
He said even though block trading desks are being used less and less by institutional investors, they remain an important trading option.
"We do use block desks. We do think they're a valuable part of our mix of trading partners," he said. "We know the value of them and we also know the disadvantages."
David L. Brooks, senior vice president and director of global equity trading at Boston Co. Asset Management LLC, Boston, said Reg NMS eventually could encourage institutional investors to trade bigger blocks of stock.
"Over the last couple of years, post-decimalization, I felt that price discovery was not as efficient as it used to be and therefore a lot of market participants were reluctant to commit a major portion of their order in the absence of comfort in trading at a particular (price) level," he explained. "But better (market) linkages, more automation and, hopefully, centralization of liquidity will help improve the price discovery mechanism."
Still, block-trading desks are not likely to rebound to handle the amount of business they did as recently as five years ago.
George L. Rodriguez, managing director of Algorithm Trading Solutions, Newark, N.J., said block desks used to provide market "color" that was valuable to buy-side firms, but with fewer firms using the desks, that market color is lacking. Algorithm Trading Solutions provides institutional investors with trading algorithms and expertise.
"In the days pre-decimalization and pre-technology, the reason a block trader or trading desk commanded a lot of respect was the fact that they were seeing institutional order flow, and that institutional flow would help that block trading desk determine the direction of the market. That was the market color," Mr. Rodriguez said.
But as regulators continue to investigate the possible leakage of information from big Wall Street firms to either their own proprietary trading desks or to other clients on a select basis — and as some cases such as the one involving NYSE specialists advance — institutional investors are becoming less willing to give up information about their big orders because of concern that brokers will use that information against them.