Nasdaq Offers Changes on Small Trades : Wall Street: Revisions to its N-Prove system follow disclosure of multiple investigations of the market. SEC approval is needed.
Under pressure from regulators, the National Assn. of Securities Dealers proposed new rules Monday that would give small investors more of a chance to buy and sell Nasdaq stocks at prices better than those quoted by dealers.
The proposals come in the form of changes to the NASD’s longstanding plan for a new system, known as N-Prove, to handle orders of up to 1,000 shares. Earlier versions of the plan had been heavily criticized by some regulators and investors’ advocates as giving small investors less overall protection than the current system, known as SOES, for “small order execution system.”
On Monday, some of those critics lauded the latest proposal as a significant improvement, but they said it still appears to contain serious flaws.
Foremost among them is that N-Prove would still allow a delay of up to slightly more than 15 seconds in the execution of small buy or sell orders. Although that delay is shorter than originally proposed for N-Prove, critics note that prices can change substantially in 15 seconds in a rapidly moving market. Under SOES, there is no delay.
The proposed new system will go into effect only if approved by the Securities and Exchange Commission. The proposed changes follow disclosure of multiple investigations of Nasdaq, including a Justice Department inquiry into possible price fixing by Nasdaq dealers and a probe by the SEC. The SEC inquiry was announced following publication of an investigative series in The Times on ways Nasdaq works to the disadvantage of small investors.
The changes proposed Monday are aimed at fixing one longstanding problem: Small investor limit orders--that is, orders to buy or sell shares only at a specified price--often go unfilled on Nasdaq, while market makers continue to trade at prices better for themselves and worse for customers.
(Market makers are the dealers who stand ready to buy or sell specific Nasdaq stocks at publicly quoted prices. Nasdaq is an electronically linked network of such dealers, unlike the New York and other stock exchanges, where floor trading in a specific stock is concentrated in the hands of a single “specialist” firm that matches orders to buy and sell.)
The major features of the new proposal include:
* Customers who place orders to buy or sell stock at the prevailing market price would automatically get a chance at any limit orders pending in the N-Prove computer at prices better than those offered by the stock’s market makers.
For example, if market makers are willing to buy a stock from the public at $20 and sell it at $20.25, investors will automatically get a chance to buy the stock at a price in between--say $20.125--if another customer has put in a limit order indicating that he is willing to sell at that price. This way, both customers benefit--the one who placed the limit order to sell and the customer who put in an ordinary market order to buy at the prevailing price.
In effect, the two customers would trade with each other unless a market maker intervened within 15 seconds and filled the market order at a price at least $0.0625 (or 1/16th) better than the limit order price. In that case, the customer placing the ordinary order would benefit from a somewhat lower price, but the limit order would sit unfilled.
* For the first time, Nasdaq would make public the information on customer limit orders through private services that provide moment-by-moment data on the Nasdaq market. However, only limit orders entered into N-Prove--and of those, only ones at prices between the buy and sell prices quoted by dealers--would be disclosed. The NASD says this would increase the chance that limit orders will be filled.
* Bowing to pressure from the SEC, the NASD agreed to extend its ban on market makers trading for their own accounts ahead of customers’ orders. So-called trading ahead, whereby dealers make trades for themselves at advantageous prices while their customers’ orders sit unfilled, has long been banned on other exchanges. But until earlier this year, it was permitted on Nasdaq. The new proposal would extend a partial ban that went into effect in June.
Jeffrey P. Ricker, a San Francisco-based consultant to institutional investors who has been critical of earlier proposed N-Prove rules, called the changes “an order of magnitude better than the original proposal.”
But he and other critics noted that the only limit orders that would go into N-Prove are limit orders of 1,000 shares or less, essentially only those put in by other small investors. The much larger number of orders put in by big customers, such as institutions, would not be in the system, so small investors most likely would never know about them, much less get a chance to trade at the better prices offered by the big investors.
In addition, small investors’ limit orders would not automatically go into N-Prove. They would have to ask their brokers to use the system, and there is no obligation for brokerage firms to do so.
Ricker said brokerage firms may have strong incentives not to want to put such orders into N-Prove. For example, putting a limit order in the system could interfere with the arrangements under which brokerages receive payment from market makers in exchange for sending them all or most of their Nasdaq orders for execution.
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More on Nasdaq
* Reprints of The Times’ recent series on the operations of Nasdaq and how they affect individual investors are available from Times on Demand. Call 808-8463, press *8630, and select option 3. Item 8535. $10.45. Mail delivery only.
