Probe Launched Into Nasdaq Stock Trading
The Justice Department has opened an antitrust investigation of the Nasdaq stock market, looking into allegations of price-fixing and other illegal practices by dealers in the nation’s busiest stock marketplace.
“The antitrust division is looking at the possibility of anti-competitive practices in the over-the-counter stock market,” said Justice Department spokeswoman Gina Talamona.
Talamona declined to answer questions about the probe, but sources who have been contacted by government lawyers said the investigation is examining the fundamental stock-trading practices of Nasdaq.
The sources said the investigation appears to be in a preliminary phase. If the antitrust division decides to go forward with the case, it could bring either criminal price-fixing charges or civil antitrust charges.
The electronically linked national market is home to the shares of such familiar companies as Microsoft Corp., Intel Corp. and Apple Computer Inc. In the first six months of 1994, its average daily trading volume surpassed the New York Stock Exchange for the first time.
Questions have been raised this year about whether Nasdaq trading may be rigged against small investors. The Justice Department inquiry follows the May release of a study by two business school professors who said they found evidence of at least tacit collusion to fix investors’ trading costs among many of the 510 Nasdaq market makers.
Major market makers and the National Assn. of Securities Dealers, which owns and operates Nasdaq, have strongly denied the existence of collusion in the marketplace.
In a written statement, T. Grant Callery, general counsel of the Washington-based NASD, said: “Neither the NASD nor the Nasdaq stock market has been contacted by the Justice Department regarding any investigation. We will cooperate fully with any such investigation when and if we are contacted.”
Market makers are the dealers who, committing their own capital, stand ready to buy or sell specific Nasdaq stocks at publicly quoted prices. They include such well-known Wall Street firms as Merrill Lynch & Co. Inc. and Morgan Stanley Group Inc. and lesser-known firms that do little besides trade Nasdaq stocks, such as Troster Singer Corp. and Herzog, Heine, Geduld Inc.
Unlike the New York Stock Exchange, where a single “specialist” firm is the sole market maker for each stock, each issue on Nasdaq (the name originally stood for National Assn. of Securities Dealers Automated Quotation system) has multiple market makers who are expected to post competing prices for buying and selling shares.
Since the business professors’ study was made public, at least 24 class-action lawsuits have been filed against major market makers on behalf of investors, nearly all alleging violations of antitrust laws.
Leonard B. Simon, a lawyer in San Diego with the firm of Milberg, Weiss, Bershad, Specthrie & Lerach, which filed one of the cases, said a judicial panel consolidated most of them Monday, assigning the suits to U.S. District Judge Robert W. Sweet in Manhattan.
The sources said the Justice Department has formed a task force of staff lawyers and economists to scrutinize Nasdaq, with participation by at least one regional antitrust division office as well as the department’s headquarters in Washington.
The lawyers have interviewed several market makers who are anxious to cooperate in the investigation. They also have spoken with officials of the federal Securities and Exchange Commission, the business school professors who wrote the critical report and several of the lawyers who filed class-action suits.
Members of the task force have also spent time sitting on Nasdaq trading desks in recent weeks, the sources said.
In their paper, to be published in December in the Journal of Finance, William G. Christie of Vanderbilt University and Paul H. Schulz of Ohio State University found that for many of the largest Nasdaq stocks, dealers seemed to always quote prices in a way that maintained at least a 1/4-point, or 25-cent “spread.”
These spreads--essentially the market makers’ profit margin--are the gap between the “bid” price (the price at which a market maker is willing to buy a stock) and the higher “asked” price (at which the firm is willing to sell).
On the New York Stock Exchange, by contrast, spreads for most stocks are 1/8 of a point, or 12.5 cents, an NYSE spokeswoman said.
The professors found that for 71 out of 100 of the largest Nasdaq stocks, market makers seemed never to quote prices in “odd eighths” of a point. In other words, bid or asked prices could be 20, 20 1/4, 20 1/2 or 20 3/4, but never 20 1/8, 20 3/8, 20 5/8 or 20 7/8--even though such quotes are common for other stocks.
The direct result was that spreads in these stocks were never less than 1/4 of a point. And the wider spreads end up costing investors, in the aggregate, millions of dollars every year.
Christie and Schulz concluded that the only possible explanation for the spreads was “tacit collusion” among market makers.
Shortly after their report was made public, spreads for a few of the stocks they cited--including Apple, Microsoft and Thousand Oaks-based Amgen Inc.--suddenly narrowed to 1/8 of a point.
The sources said the Justice Department inquiry has broadened beyond looking at possible collusion on spreads to other alleged anti-competitive practices. These include allegations that market makers refuse to honor their posted prices and that the dealers systematically prevent customers from finding out about offers from fellow investors to buy or sell at prices better than those available from the market makers themselves.
Although not the first time the antitrust division has gotten involved in securities matters, the inquiry represents an unusual foray into an area normally left to the SEC. Anne K. Bingaman, appointed by President Clinton to head the division, has led the unit into a series of new initiatives after a long period of relative dormancy.
SEC Chairman Arthur Levitt Jr. has been moving to impose some new restrictions on Nasdaq, aimed at getting better prices for individual investors. But John C. Coffee Jr., a Columbia University professor specializing in securities law, said the Justice Department is better equipped than the SEC to deal with any broad problems that exist in the market’s operations.
“This is not the kind of case that the SEC specializes in,” he said of the allegations of collusion, adding that the antitrust division is “much more used to dealing with a whole pattern and practice by a very large industry.”
Officials of several large Nasdaq market-making firms--including Morgan Stanley Inc., Charles Schwab & Co. (which owns giant Nasdaq market maker Mayer & Schweitzer Inc.), Troster Singer Corp. and others--either declined to comment or said their firms were unaware of an investigation.
