It’s been called “The Odd Couple” alliance: The New York Stock Exchange, that 213-year-old icon of American capitalism, acquiring Archipelago Holdings Inc., a 9-year-old upstart firm from Chicago.
But if their deal is approved as expected Tuesday, old and new will merge operations, and Archipelago’s chief executive, Gerald R. Putnam, will become co-president and chief operating officer of the NYSE Group, while his technology will transform the way Big Board trades are made.
By incorporating Archipelago’s electronic trading system, customers of the new NYSE will be able to flash through a transaction in one fifth of a second. Now trades on the NYSE manual system take an average of 12 seconds and more than one-third of a second on its electronic system.
Perhaps as important as the upgrade in speed, Big Board customers won’t be limited to trading in stocks on that exchange.
“Archipelago’s great innovation was delivering a fast, open electronic marketplace with fair, set rules that lead to consistent execution and quality,” said Putnam, who co-founded his company.
In the 1990s, when Archipelago introduced its one-stop shopping, Putnam recalled, “Our competitors–Bloomberg, Instinet, Island–opted to close their pools of liquidity and not provide connectivity to other markets. We connected with them all and offered that access to our customers.”
Putnam, 47, learned the brokerage business from the ground up. In 1980, he started working as a broker and in 1983 landed at Walsh Greenwood & Co., a New York trading firm, where he stayed until 1987.
There, Putnam learned about the importance of technological advances in trading. Walsh Greenwood had developed one of the first real-time, personal-computer-based quote systems, which gave customers instant access to up-to-the-minute market data such as the last sale price of a stock.
As a broker, Putnam held seven jobs in 12 years; he was fired from two. “I couldn’t find a steady job until I started my own business,” he said.
In 1994 he launched Chicago-based Terra Nova Trading LLC, an online broker of stocks, options, futures and other products.
Then in 1996 came new rules from the Securities and Exchange Commission aimed at quelling complaints of unfair trading. An illness gave Putnam time to cogitate.
“I caught a virus and was stuck in bed, so I read hundreds of pages of rules,” he said. Buried within them was an opportunity to start a new type of business, called a qualified electronic communications network, or ECN. While it would pay a third party to clear its trades, it could operate like an exchange, but with fewer regulations.
Open access offered
That was the genesis of Archipelago LLC, which Putnam co-founded late in 1996. Through Archipelago, Putnam, as chief executive, introduced his one-stop-shopping concept: Archipelago gave investors access to all marketplaces while competitors were more selective.
“Necessity is the mother of invention,” said Putnam. “As a start-up with no customers, if people came to our platform there was no liquidity, no one to trade with. So we said, `If you trade with us you’ll have access to all the other platforms.'”
Archipelago customers, for example, could access Nasdaq systems. Archipelago also used Nasdaq’s SelectNet system to attract new customers.
“They had a computerized order routing system, SelectNet, that gave all investors–not just subscribers–access to their liquidity,” he said. “Since it was a two-way system, we reversed it to get new customers.”
Luckily, at first, “We were so small, no one noticed us,” he explained.
In 1999, his fledging company attracted investments of $25 million each from Goldman Sachs Group Inc. and E-Trade Group Inc.
“That gave us credibility; people knew we’d be around,” he said. That same year an additional $130 million flowed into Archipelago from investors such as Merrill Lynch and J.P. Morgan & Co.
Also in 1999 the SEC encouraged debate over whether there should be more exchanges. Putnam said he realized that if Archipelago could become an exchange it could lower its operating costs by clearing its own trades and by selling real-time market data.
“Even though it meant more regulation, the economics were better,” Putnam said.
So in August 1999 Putnam applied to the SEC for permission to start a new exchange. But his application languished. He met with then-SEC Chairman Arthur Levitt. “I asked if it’d be easier to deal with us if we acquired an existing exchange,” Putnam said. In 2000, Archipelago did just that, acquiring the equity business of the Pacific Exchange for $80 million.
“That turned us around from losing money to profitable,” he said. Archipelago Exchange lowered expenses for clearing fees by about $60 million a year and raised an additional $20 million in revenues selling market information. (Two months ago, Archipelago purchased the rest of the Pacific Exchange’s parent company, PCX Holdings Inc., including its options business, for $67 million.)
In 2002, Goldman Sachs agreed to sell its electronic communications network, RediBook, to Archipelago. While Goldman was an investor in Archipelago, as the owner of another network it was also a competitor.
“They could have gone two ways: to compete or combine their ECN business with us,” Putnam explained. “Eliminating another major competitor catapulted us into a leader.”
In spring 2003, Putnam proposed combining Archipelago with Nasdaq. (Archipelago now does about 23 percent of the trades in Nasdaq-listed offerings.) “We couldn’t settle on the relative value of the two companies,” he said.
In August 2004 Putnam took Archipelago public, establishing a market value for the company.
Transparent vs. opaque
Putnam also kept his sights set on another rival he enjoyed excoriating, the New York Stock Exchange. “We would say that we were fast, transparent and open and they were slow, opaque and closed,” he said.
Last January at the urging of his chief financial officer, Nelson Chai, Putnam met with John Thain, the NYSE’s chief executive, to propose a marriage between Archipelago and the Big Board.
“I was skeptical and scared that if word leaked it could hurt Archipelago, especially if [the deal] didn’t happen,” Putnam said.
Talks were so secretive that announcement of the deal stunned many Wall Street observers, recalled Richard Herr, vice president of equity research at Keefe, Bruyette & Woods Inc.
E-mails dubbed the alliance “The Odd Couple,” proclaiming, “Felix and Oscar are together again!” Herr said. But now, the wisdom of this pairing is apparent.
“It’s a marriage, not just an acquisition,” said David S. Ruder, a former SEC chairman and now a law professor at Northwestern University. “New York, a manual exchange, is buying an electronic exchange, its brain power and Jerry Putnam, who’ll have a lot of power.”
The NYSE had to change, Thain has acknowledged. It has been losing market share of trades in stocks listed on its own exchange. With Archipelago, the NYSE acquires an all-electronic exchange and its talent while retaining the NYSE hybrid electronic-manual system.
It will diversify from trading stocks listed on the NYSE to trading over-the-counter securities, options and other products. With the deal, it also becomes a public corporation.
Archipelago, meanwhile, ascends to become part of a global exchange that is perhaps the world’s most respected financial marketplace.
“Archipelago alone may not have had such a bright future,” said John Coffee, director of the Center for Corporate Governance at Columbia University.
Said Putnam, “I’d say the opposite, that the NYSE’s future is brighter with us.”
`Merger of necessity’
Others are less sanguine. “This is a merger of necessity and with competition increasing, it isn’t a given that NYSE Group is a clear winner,” said Sang Lee, managing partner of Aite Group LLC, a research and advisory firm.
Some predict a culture clash between Archapelago and the NYSE’s more deliberate traditionalists.
“[Thain is] respectful that it’s a change for me,” said Putnam.
Jamie Selway, a former Putnam employee, said Putnam “doesn’t let political niceties stop him, and that can make for a rugged place.”
Putnam knows he must change. “I’m not CEO anymore,” he said.
But foreshadowing an interesting evolution ahead, he opined, at Archipelago Exchange “we do things from the bottom up, and New York probably needs more of that.”
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sdiesenhouse@tribune.com
