Study Suggests Collusion Among Brokerage Firms : Wall Street: Findings by two business professors indicate a possible rigging of trades on the Nasdaq market.
A new study strongly suggests that the nation’s brokerage firms collude with each other to rig over-the-counter trading and ensure themselves artificially high trading profits at the expense of investors.
The study by two business professors examined price data for the stocks of 100 large companies traded on the Nasdaq market for over-the-counter stocks, and is believed to be the first to examine such price data in great detail. It came up with the seemingly bizarre finding that for 71 of these stocks--including such giant companies as Apple Computer and Lotus Development--prices were almost never posted on Nasdaq in “odd eighths” such as 22 1/8, 22 3/8, 22 5/8 and 22 7/8.
As a result, the spread between “bid” and “asked” prices--in effect, the profit the brokerage firm makes on each share traded--was almost never less than a quarter of a point, or 25 cents per share.
The study, most of which was immediately condemned by Nasdaq, comes as criticism of the fairness of over-the-counter trading has escalated in recent months. It also comes at a time of fierce rivalry between the highly computerized Nasdaq system and exchanges such as the New York Stock Exchange and American Stock Exchange. Nasdaq has used fairness and efficiency as a key point of its marketing.
The authors of the study--Vanderbilt University business professor William Christie and Ohio State University business professor Paul Schultz--made copies of their report available Wednesday. Christie said it was accepted for publication in the next issue of the Journal of Finance, due out in about six months. The journal is the official publication of the American Finance Assn., an organization of professors who specialize in economics, business and finance.
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The study initially examined data for the full year 1991, and then went back and confirmed the same results for 1994 to date, according to Christie.
Richard G. Ketchum, chief operating officer of the National Assn. of Securities Dealers, which operates Nasdaq, didn’t dispute in an interview that the 71 stocks almost never trade at spreads narrower than 25 cents. But he said there are legitimate reasons. He said the study “is irresponsible and in fact we believe it is slanderous.”
The authors emphasized that they have no conclusive proof of collusion, which would violate securities laws. But after analyzing and rejecting other possible explanations, they stated “we are unable to offer any other plausible explanation for the lack of odd-eighth quotes.”
They noted that in rare instances when the stocks were quoted at such prices, the prices typically were posted for less than two minutes before being removed. The authors noted that there were several ways dealers could punish maverick rivals who tried to narrow the spread, including the diversion of trades.
In an interview, Christie said he believes the Securities and Exchange Commission should launch an investigation of OTC trading. Brandon Becker, the SEC’s head of market regulation, couldn’t immediately be reached for comment late Wednesday.
Wall Street firms that are large “market makers” in OTC stocks didn’t seem eager on Wednesday to comment on the charge of price collusion.
A spokesman for Merrill Lynch, the nation’s largest brokerage firm, said the firm had no comment. Prudential Securities and Smith Barney Shearson also didn’t respond to repeated calls seeking comment.
Securities firms in the past have maintained that the OTC market is fair and that spreads are needed to compensate them for the risks they take in trading and providing liquidity.
Unlike the highly computerized Nasdaq, the NYSE, Amex and other exchanges rely on a much older system in which individuals on the exchange floors, called specialists, match buy and sell orders. Nasdaq has contended that its system, in which dozens of brokerage firms linked by the computerized trading network make a market in the same stock at the same time, has greater competition that works to the benefit of investors.
In the Nasdaq system, two prices are posted for each stock: the bid price and the asked price. The bid price is the one at which brokers are willing to buy a stock; the asked price is the one at which they are willing to sell. The difference between the two is known as the spread, and it represents the profit the firms make for acting as middlemen in the trades. On the Nasdaq, small investors can almost never obtain a stock at anything lower than the asked price.
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Ketchum cited a study of stock trading in Australia that, he said, shows that spreads in over-the-counter trading tend to gravitate naturally to a quarter point. He noted that many of the stocks listed on Nasdaq are more volatile and thinly traded than those listed on the NYSE or Amex, and said dealers may set wide spreads so that they can be sure of meeting all of a customer’s order at the posted asked price.
Eighths of a point, or 12.5 cents, by tradition are the smallest increments at which prices move on stock exchanges. But the SEC, in its recent Market 2000 report proposing changes in the nation’s trading system, recommended that the smallest increment for all exchanges be reduced to a sixteenth of a point.
