By Shawn Tully

(FORTUNE Magazine) – ON THE FRENETIC FLOOR OF THE NEW York Stock Exchange in late April, the roisterous, jacket-clad brokers were buzzing about a dramatic deal that might hasten the end of their way of life but would also ensure that the institution they revere remained the world's premier market for decades to come. The crew on the floor admires smart traders, and the new boss was grabbing the best tick. John Thain had managed to recast what most investors viewed as a dusty relic into a cutting-edge technology powerhouse with his plan to merge the NYSE and Archipelago, the big electronic marketplace. So far, Thain's big deal is winning kudos from the press and enriching the NYSE's owners by driving up the price of its seats an incredible 68%, to $2.6 million, near the 1999 peak. At the same time Thain orchestrated what appeared to be a trophy trade: swapping modernization for an extension of SEC rules that, on the surface, virtually guarantee NYSE dominance in its listed stocks for many years to come. Soaring seat prices, fresh technology, and best of all, a near monopoly--could the world possibly look rosier from the corner of Broad and Wall?

We don't want to spoil the party, but the Big Board's reversal of fortune may be an illusion. What's gone mostly unnoticed is that far from perpetuating the NYSE's monopoly, the SEC's new rules strip the exchange of the protection from competition it has enjoyed for decades. The deal to buy Archipelago is really a defensive maneuver that could eventually turn the NYSE into just another electronic communication network (ECN), and though it may remain the biggest, its days as an impregnable fortress are ending. "The new SEC rules mean that the NYSE must become the equivalent of a good, efficient electronic system just to compete," says Harold Bradley, SVP of American Century Investments, the big mutual fund company.

This will have real impact on individual investors. The SEC is yanking off the NYSE's armor by radically altering the famous "trade through" rule that gives the NYSE a lock on its listed stocks. The regulation, approved on April 6, makes two crucial changes that will take effect in mid-2006.

The first is well publicized: It removes all protection from the superslow system of specialists and brokers that's been the NYSE's hallmark. Today the trade-through rule requires that all investors place their orders on the exchange that posts the "best price." For its listed stocks, that's almost always the NYSE. The problem is that the Big Board's "best price" is often illusory. By the time the order works its way down to the floor, frequently a matter of seconds, the posted price may be long gone, forcing the buyer to resubmit the bid at a higher price. The SEC's new rule eliminates this protection, probably sealing the fate of the floor brokers and specialists. Says Larry Leibowitz, chief operating officer at UBS Americas Equities: "The new rule means that the trading of most big-cap stocks, which are now traded on the floor, will go largely electronic."

But a second little-noticed change is the real haymaker. The NYSE will be forced to post its quotes electronically, and for most of these automated trades the SEC will no longer offer trade-through protection. That's a potential nightmare: Right now the NYSE typically posts bids for the best price for only a small number of shares. Say a buyer wants wants 5,000 shares of IBM, and the NYSE is showing a quote of $70.03 for 1,000 shares, while INET is offering at $70.04 for all 5,000 shares. Today, the customer can't buy the NYSE shares and simultaneously purchase the other 4,000 on INET. He must wait until the NYSE fills the order for 1,000, then send out a new order. By that time, the price may have risen. Under the new rules, called the "intermarket sweep" provision, he can buy 1,000 shares on the NYSE at the "best price" while instantaneously sending out an electronic request for the best deal on the other 4,000 shares to a host of ECNs. To compete in this new world, the NYSE will be forced to act like any other ECN by revealing firm prices for all the shares it has to sell, or as they say in the trade, offering an "open book." Investors will reap rich benefits. The NYSE, longtime bastion of privilege, will never be the same. -- Shawn Tully