By Cheryl McDonald
Nick Niehoff, the mastermind behind the automation of the Cincinnati Stock Exchange (CSE) and the progressive business expert who changed the scope of the stock market forever, believes there is a strong connection between art and automation. He likens the automation process he oversaw to art, architecture and music combined.
“If you can see the big picture on a blank canvas and be the architect of the infrastructure, then it’s up to the conductor to make it all play together,” he says.
Though he’s clearly a numbers guy, Nick Niehoff defies stereotypes of science-and-math-loving computer geeks typing away on computer terminals, pocket protectors firmly in place. Buck Niehoff, Nick’s younger sibling and a long-serving member of the University of Cincinnati’s Board of Trustees, explains.
“That’s the surprise in the story,” says Buck Niehoff. “He was not really good at math or science. I don’t think he knows very much about computers, either. I think he has a computer because occasionally he e-mails me something, but he’s certainly not a computer nerd.”
With a brother’s insight and humor, he offers the rather shocking description of the unlikely candidate who led the automation of the stock exchange. “My brother was actually a good artist, but I don’t think he took other [classes] than whatever mandatory math was required at UC,” Buck Niehoff remembers. “I don’t think he took any other math or science or that sort of thing.” Nick did attend classes at the College of Design, Art and Architecture at UC, though, “when our father, who was paying the tuition bills, was not looking.”
So how did this non-computer guru who didn’t like numbers or math lead the computerization of the Cincinnati Stock Exchange? Buck Niehoff offers some insights.
“He knows a lot about art. Perhaps it’s his artistic imagination that allowed him to see the big picture, and get other people, the computer nerds, to do it [the automation], to figure it out, and actually do the nuts and bolts of it.”
So, why did Nick Niehoff take on the formidable challenge of reshaping stock exchange operations?
“I would say that one characteristic of my brother is that he’s very conservative and traditional, except that occasionally he has these little bursts of independence, of rebelliousness, like buying that 1930s Chevrolet when he was 15 years old,” Buck Niehoff says. “I think in some ways his getting involved with the CSE and taking it to a new level with computerization, was an example of that–his willing[ness] to risk something even though most of his life was very traditional, very conservative, always doing what was expected.”
As president of the CSE during the tumultuous 1970s and 1980s, Nick Niehoff used that capacity for boldness at local, national and international levels. He explains that his determined support of a National Market System and automation led to a tense battle between the New York Stock Exchange (NYSE) and the CSE. He shares some of the challenges of going up against industry giants.
“It wasn’t that we picked the battle, we were just in the battle,” Nick Niehoff says. “We took on the largest financial institution in the capitalist world (NYSE). It was a very unpleasant experience at various points in time.”
The NYSE had a huge amount of money and an ATM-like war chest to fund their fight against automation of the stock exchange. Automation, its leaders understood, would change the landscape, and re-define jobs, for the future. Brokers and executive managers happy with the status quo knew how to make their competitors very uncomfortable, Niehoff says.
In response, he surrounded himself with like-minded industry experts who had “hard skin” to put up with this tough environment. Still, there was a point where CSE staff was afraid for their personal safety.
“We thought, we’ll be standing at corner of 4th and Walnut streets thinking, ‘Why did we just get run over?’ “
But Niehoff had recruited a smart and stubborn team.
Buck Niehoff agrees that his brother’s fears were warranted. “Yes, there was the threat of being blackballed,” he says. “It was very courageous of him [Nick Niehoff] to take on the industry.”
Buck Niehoff contrasts his brother’s personality with this intimidating task.
“This is all against the backdrop of [Nick Niehoff] being a Brooks Brothers conventional banker, having a very conservative lifestyle. That’s the interesting thing.“
Peter DuPont was the President of Control Data Corporation’s (CDC) Electronic Trading Services (ETS) division, the company that worked with Nick Niehoff and the CSE on the automation project. He confirms Nick Niehoff’s assessment of the challenges of automation.
“We knew that we had formidable opponents, primarily the NYSE,” DuPont says. “They didn’t recognize that they were being overtaken by technology.”
The NYSE promoted a different model for the future than the CSE. They supported the “floor model,” a people-dependent system that relied heavily upon specialists and brokers working on the floor of the exchange.
“The specialists were the ones who were most firmly entrenched against anything resembling the system that we developed,” says Nick Niehoff. “So we had a fight on our hands. We had not only the NYSE to contend with, but we had the Securities Exchange Commission (SEC), which basically was supportive but in a limited way.”
DuPont remembers his exposure to the industry during the development of automation.
“At the NYSE, we had meetings with the executives, who were polite but not receptive,” DuPont says. “We also engaged Arthur Levitt, who was the chairman of the American Stock Exchange. We never really got much involvement or support from him.”
Levitt departed the AMEX and became the chairman of the SEC.
DuPont explained that the CSE had to return to the SEC on multiple occasions to get the authorization for the automation project extended because the CSE was operating as an SEC pilot program.
“We finally got the permanent status from the SEC so we didn’t have to keep going back to the well for more approvals,” DuPont says.
Buck Niehoff was confident that there were other examples of his big brother’s boldness. He recalls Nick’s hobby of “tinkering with cars” and a specific incident that showed his personality as a teenager.
“When he [Nick Niehoff] was 15 years old, before he was legally able to drive, he bought a 1930s Chevrolet from a used car lot somewhere. He drove it home even though he wasn’t licensed. Our father was furious. That was probably one of the biggest disasters my brother created in our family.”
Niehoff brought that same determination with him to his work with the CSE. Before the 1975 Amendments to the Securities Exchange Act (also known as the May Day amendments, or specifically Regulation NMS, or National Market System), and the deregulation of stock markets, a typical day at the Cincinnati Stock Exchange (CSE), or any stock exchange in the US, began with an opening time of 10 a.m. and closing time of 3 p.m. Brokers and specialists would arrive at their posts with their pockets stuffed with orders to process. At the ringing of the bell, brokers would approach specialists and call out the orders. This very manual and labor-intensive process was likely the root of the market’s limited hours, says Niehoff.
“People would be tired,” he says. “It was tiring keeping all of the paperwork flowing, and more to the point, accurate.”
The CSE staff operated from trading desks where the brokers’ orders were collected and then sent to the exchange for execution, an awkward and time-consuming process that perturbed Nick Niehoff.
“There were too many links in the chain,” he says. “It seemed that with modern telecommunication techniques, certain streamlining could occur.”
His frustration dovetailed with the 1975 NMS Securities and Exchange Regulations. The new regulations addressed major markets’ ability to hide behind a fixed rate structure, which ensured high brokers’ fees with no competition. With help from the CSE and automation, that antiquated business model would soon disappear.
Because Regulation NMS was an un-fixed rate structure that allowed for variable rates among brokers and their customers, competition entered the marketplace after 1975. For the first time, customers exercised more power in controlling the price of placing orders and trades. Customers could negotiate prices, and discount brokers, such as Charles Schwab, arrived on the scene to execute orders more cheaply. Their belief was simple: the location of the trade should not dictate the share price.
“Whether it’s on the CSE or the NYSE, 100 shares of Duke Energy stock is still 100 shares,” Nick Niehoff explains.
As director of the CSE, chairman of the CSE Board, and a player in the securities business, Nick Niehoff was engrossed in all aspects of stock-trading. All of the nationally registered U.S. exchanges operated under the guidelines of the SEC. Therefore, they were all under mandates to automate their processing capabilities for their members. The SEC saw automation as a way to save public customers money. Nick Niehoff saw opportunities to make the most of this shift by using telecommunications technologies and computers to automate the stock exchange processing of member firm orders.
Although these technologies were somewhat foreign to him, Niehoff was well-versed in securities, banking and investing. He well understood how capital flowed through the financial markets. His family had been working in the securities business since 1900, with 110 years and three generations of success in the financial world.
“Everyone in my family has been in the securities business,” Buck Niehoff says. “My grandfather was president of a regional investment firm called Weil Roth & Irving with offices in Cincinnati, Detroit, Chicago and New York.”
His father, Karl Niehoff, became president of that company, and in the late 1960s, the Niehoff family sold the company to a larger firm, the Ohio Company. Twenty years later, the Ohio Company was sold to 5/3 Bank. “In a way, our family firm is part of 5/3 Bank,” he says.
Ironically, Nick Niehoff started his business career in the corporate trust department of 5/3 Bank in1968. He then worked as vice president and secretary of Weil Roth & Irving until it was sold. Both Buck Niehoff and their father’s brother, Richard Niehoff, worked as municipal bond attorneys. Nick Niehoff’s son carries on the tradition as an investment counselor at a regional investment bank brokerage company in Boston.
It was only natural, then, that Nick Niehoff started his quest for automation partners in his hometown. Cincinnati Bell was one of the few independent telephone companies, or Baby Bells, left in the country. He approached both Cincinnati Bell and AT&T to discuss a collaborative venture to automate the CSE. One of the major challenges, he knew, was sending data over telecommunication lines.
“It made no sense to phone up orders, and have them written at the booth,” he says. Instead, he worked toward direct linkage or access to the market, which would eliminate human intervention and paper.
“Once we provided the brokers with system processing technology, then we had to make it available for the specialists,” Nick Niehoff says. “And in the case of the CSE, it was imperative to provide system technology to the multiple dealers that functioned as CSE competing specialists who were geographically dispersed throughout the U.S.” To him, it seemed logical to find or develop software programs that could compile computer files of stored orders instead of paper files and books that had to be manually sorted.
As Nick Niehoff became increasingly involved with the CSE as a board member, he resigned from his brokerage business. This was around the time that the CSE president retired, so Nick Niehoff threw his hat in the ring for that leadership position. After several months of searching and interviewing, he was offered the full-time presidency position.
As president, armed with direct control of the operations of the CSE, he began his search to find companies that specialized in computerization. IBM ranked high on his list, as did other companies that no longer exist today. He located Control Data Corporation (CDC), which he describes as focusing on “controlling data flows and arranging data in methods that were unique to the industry.” CDC’s work, he thought, lent itself to programs and computerization.
With Niehoff’s endorsement, CDC was selected to be the CSE’s software manufacturer and data center provider. No exchange in the Unted States had taken such a bold step. At that time, the national exchanges lacked the skills to operate data centers, run telecommunications switches and write software.
“We knew about regulations, we knew about rules, we knew about members, we knew about listing and delisting stock, we could turn on the lights at the beginning of the day and turn off the lights at the end of the day,” Niehoff says. This was the business of exchanges. Operating data centers, telecommunication facilities and programming computers was a whole new world of responsibilities.
CDC knew how to do what exchanges did not, so Niehoff negotiated and signed an operating agreement with CDC.
At that point, the unconventional Niehoff thought even bigger. If the CSE can automate, then why not partner with other regional exchanges, such as Chicago, Pacific, Philadelphia and Boston, to see if they would be interested in utilizing the CDC and CSE System, dubbed the “NSTS” (National Securities Trading System)? If the regional exchanges worked together utilizing a telecommunications network, they could easily send orders back and forth from one exchange to another in an effort to seek better-priced executions for the member firm’s customers’ orders.
For example, if an occasional order for a Boston company’s stock, such as Gillette, showed up at the CSE, it could be sent to the Boston Stock Exchange specialist, and conversely, if an order for Procter & Gamble stock came into the BSE, the BSE specialist could transmit the order to the Cincinnati Stock Exchange, where there was generally a deeper and more liquid and competitively quoted market for the hometown stock.
Niehoff wanted orders to travel smoothly from exchange to exchange in an effort to find the best execution possibilities, a process that became very easy to do with data transmission lines.
“How will a broker or specialist in Boston detect there is a deep and liquid market for Procter & Gamble stock at the CSE?” he asks.
The regional quotation network allowed all the participants to see each other’s quotes. The New York Stock Exchange (NYSE) began exploring a national quotation system that would connect all of the exchanges. Nick Niehoff joined the discussions, as did leaders of other exchanges.
The result? A consortium of all the exchanges could build a robust facility to calculate a national quote and disseminate it as broadly as possible–the National Quotation System. The CSE discontinued its individual quotation system, except for its own members, and sent quotes to this newly consolidated national system, also known as the Consolidated Quote System. It is still in effect today and is the cornerstone of national markets.
This same consolidation process evolved with the stock exchanges’ ticker tape. Each exchange had its own unique tape, an inefficient model for a consolidated system. So, in 1975, all of the individual exchange tapes merged onto the same tape, creating the Consolidated Tape Association.
As Nick Niehoff and the CSE moved further into automation for regional exchange members, it became clear that the technology that had been developed gave CDC a significant amount of expertise in manufacturing software and maintaining computer hardware and computer programs. The new way of doing business was winding its way into U.S. brokerages and exchanges.
Niehoff believed that the next stage of development would involve looking for economical ways to reduce prices of trades. CSE members wanted to reduce costs to keep public customers from paying exorbitant commission fees, another goal of the SEC’s NMS regulation. Once again, the CSE sought answers from CDC.
CDC’s programmers wrote another generation of software and formed BTSI (“Brokerage Transaction Services, Inc.”) to continue to streamline the trading process. The CSE integrated the BTSI processes into its NSTS.
Under Nick Niehoff’s leadership, the CSE was always in search of “cheaper, faster, better software and cheaper, faster, better hardware,” he explains. Technology trends made transitions more natural, and companies soon realized that they had to take their antiquated mainframes down. Nick Niehoff describes the old computer system that seems unfathomable to our uber-technology-crazed minds: “If you were on the observation deck of the Empire State Building and looked down on the rooftops of some of the buildings in Manhattan, it looked like there were swimming pools on the roofs of those buildings. In reality, these were water ponds that were the cooling “tanks” for the water that ran through the monster mainframe computers, to keep them cool. It was the primitive form of air-conditioning and cooling for the monster machines that took up the space of an entire building floor.”
As the CSE became more cost-effective, a “war” erupted, says Niehoff. There was a point in time when the CSE had between 300 and 400 members, while the NYSE had no more than 300 members. Brokerage firms joined the CSE at a very rapid rate because their execution process was so streamlined and the costs were highly competitive. It was no longer necessary for the Charles Schwab office in San Francisco to have brokers in Cincinnati to make a transaction. Automation allowed data lines to transmit the orders throughout the country in search of best execution at a fair price.
The computers that ran the CSE were located in the CDC’s computer facility in Jersey City, NJ. Peter DuPont, of CDC, managed the operations of the data center. By 1979, CDC had been approached by Weeden & Company with a proposition to buy an automation trading system known as WHAM that Weeden had developed. A number of other brokerages were also considering being part of this consortium. CDC consulted with companies that had been involved with “the WHAM experimental system,” the most prominent of which was the brokerage firm Merrill Lynch. Brokers at Paine Weber also preferred more efficiencies and automation in trading. With Merrill Lynch’s promise of support and interest from Paine Weber (which was never realized), Charles Schwab, UC alumnus Edward Wedbush’s brokerage firm and Cincinnati’s W.D. Gradison & Co., CDC acquired the WHAM venture.
The cost was in the $100,000 range, according to Niehoff. It was a very small-scale operation, and it needed a lot of improvement and expansion, but CDC grew to a staff of 10 and began a significant sales campaign. Eventually this system was abandoned in favor of a new architecture. But Weeden’s system served an interim purpose that allowed CDC staff to visit brokerage firms and persuade those already involved to expand their participation. Peter DuPont remains glad that he was part of this piece of financial history.
“I think it was a noble experiment for CDC,” DuPont says. “I think the basic ideas were good. The seeds were planted for essentially replacing the NYSE’s floor environment model and going to automated trading. The advances in trading volume that we are experiencing today certainly would not have been possible if the old model had persisted.”
Although the new approach was a success, there were challenges in staying ahead of the volume. DuPont explains that volume was fairly modest, but the system was fairly modest, too. It wasn’t originally designed to handle large volume.
“Today, people would laugh at what was essentially a teletype system printing at very low speeds,” DuPont says. “Today, trading terms are talking about not only low mili, but micro-seconds. In terms of bids and offers, we have come a long way.”
Even more difficult was the task to gain participants and grow volume and revenue. Obviously, CDC needed to make money. Company leaders believed that if this venture was successful, it could transform the industry. And, being a computer manufacturer and designer of systems, CDC could play an important role in the national market. While the complete revolution never happened, DuPont is still grateful for the experience.
“Like a lot of bets, this did not pan out,” he says. “But I think it was a good try. I certainly enjoyed it. This was one of the more enjoyable parts of my business career. I think we were a little ahead of our time.”
DuPont has worked as a part of SunGard, a software and information technology services company with more than 25,000 customers in more than 70 countries, for the past 15 years. His colleagues little suspect that they work with a pioneer of the automation of the stock exchange.
“I’ve sometimes talked about (my role),” he says. “Like how we moved our baud rate up from 75 to 100. The younger people roll their eyes.”
He compared moving the baud speed (the rate at which data is transferred) from 75 to 100 to putting a man on the moon. Today, telephone lines run at approximately 9600 baud.
While floor-based exchanges persisted, NASDAQ began to look like the CSE; it engaged both a hardware and software company to automate its exchange, the Bunker Ramo Corporation.
Nick Niehoff and the CSE welcomed NASDAQ’s shift, in part because the two exchanges operated in very distinct markets. NASDAQ was copying the trading method that the CSE had modeled using multiple dealers and quote display screens, but NASDAQ, being the OTC market, did not take away from the CSE listed exchange business. Meanwhile, the CSE continued to grow by doing things better, faster and cheaper.
Today, NASDAQ is completely automated while the NYSE is still operating in a semi-manual mode.
Nick Niehoff knows that automation came at a very real cost. “The capital expense just to acquire the hardware and manufacture the software was $3 million for just the first year. That was very expensive, and no other stock exchange in the US, not even the NYSE, had invested that amount of money into automating in the late 1970s.”
In the 1970s, there was no Internet, no Facebook, no Twitter and no My Space. Even communicating to his staff was a challenge.
“I had a 40-button phone set that connected me to 40 people at once,” he says. “That’s how we did it.”
Five workers alternated turning on the markets remotely from Cincinnati.
“We would send test messages through the system, and say something like, ‘Chuck Schwab, are you there? Are you polling?’ “
Nick Niehoff’s vacations were few and far in between. He was regularly traveling from Cincinnati to New York, from meetings at the CDC data center in Jersey City to visits to member firms.
Nick Niehoff was in his late 20s and early 30s when he worked at the CSE and he admits the costs were more than just monetary. Did he ever envision walking away from the automation project?
“Sure, I wouldn’t be truthful I if didn’t say that,” he says. “Saturday mornings, I would be doing financial work and I would ask our chief financial officer, ‘Are we even making any money and paying our bills?’ Then a new member firm would come on, and it would be an exciting moment.”