Tightening the Screws on Nasdaq Exchange : Pressure is applied to stock network from several directions
Is trading on the Nasdaq--the nation’s busiest stock exchange--skewed against small investors? Questions about the fundamental fairness of the Nasdaq system have been raised by Times staff writer Scot J. Paltrow in a riveting six-part series on the exchange’s controversial practices.
The National Assn. of Securities Dealers, which operates the Nasdaq, maintains that all is in order at its exchange, where such familiar stocks as Microsoft, MCI and Apple trade daily. But the Justice Department’s antitrust division recently confirmed that it is looking into alleged anti-competitive practices on Nasdaq, including possible price-fixing by market makers--firms that put up their own money to “make a market” in particular Nasdaq stocks and act as dealers. Separately, class-action suits have been filed challenging Nasdaq practices. The Securities and Exchange Commission also is beginning to apply strong pressure on the exchange to address its problems.
FAR-FLUNG NETWORK: What makes the Nasdaq unique is that the stock exchange has no trading floor. It is a nationwide network of 510 market-making firms linked by a computer system and telephones. This fragmented electronic trading system, which has an average daily trading volume of 299 million shares, often fails to make the market’s best prices available to small investors.
Paltrow’s investigation found that individual investors are much more likely to get fair treatment for their trades on the New York Stock Exchange than on the Nasdaq (the name originally stood for National Assn. of Securities Dealers Automated Quotation system). On the NYSE, big and small orders are executed on a relatively equal footing. But on the Nasdaq, small investors get a worse price for their trades than large pension and mutual funds.
The cornerstone of the nation’s securities laws is the “best execution” rule. This is designed to guarantee that brokerage customers get the best price available when they put in orders to buy or sell stocks. A pattern of questionable Nasdaq practices and lax self-enforcement of Nasdaq requirements work to the disadvantage of small investors.
A fundamental problem is Nasdaq’s wide spreads, or gaps, between the price that market makers are willing to pay to buy a stock and the price at which they are willing to sell. Nasdaq officials publicly deny that there is price collusion, but privately they have been pressing market makers to cut the spreads.
Other questionable Nasdaq practices are: “backing away,” the illegal refusal by a market maker to honor the prices it posts in the Nasdaq computer system for buying or selling a stock; “trading through,” when market makers continue to trade with the investing public at their quoted bid or asked prices, ignoring offers that are better for customers; “trading ahead” or “front running,” in which a market maker buys or sells for the firm’s own profit before dealing with an order from the firm’s customers. Delayed reporting of trades also is a problem.
AID FOR ‘LITTLE GUY’: The SEC has proposed some strict protections for small investors. If they are approved, and they should be, Nasdaq market makers will no longer be allowed to let so-called limit orders from customers sit while they trade for themselves at better prices. But the market makers would not be required to accept such orders, so they might well choose not to take them at all. This is another loophole that should be closed.
Creating a fair and equitable market is in the interest of Nasdaq and, more important, in the interest of the small investor. As the busiest and fastest-growing exchange, the Nasdaq should operate with greater openness and accessibility for small investors. The inequities on the exchange must be addressed quickly by both Nasdaq and the SEC.
