Nasdaq’s Parent to Weigh Internal Changes : Wall Street: A committee is calling for tougher enforcement and more public representatives on the NASD board.
The Nasdaq Stock Market’s parent organization is expected today to review a report of an independent committee, and act on its recommendations, in a move to address some of its internal problems before two federal investigations are concluded.
In a meeting in Colorado Springs, Colo., the National Assn. of Securities Dealers’ board of governors is due to receive the report of the so-called Rudman Committee, appointed to look into alleged deficiencies in how Nasdaq is governed. The committee’s report recommends tougher enforcement and opening up the boards of both the NASD and its subsidiary, Nasdaq, to more public members, officials who have been briefed on it said. Ian B. Davidson, the board’s chairman, said it is likely to act today on at least some of the recommendations.
The Rudman Committee’s report caps 10 months of inquiry, all behind closed doors. It looked into complaints that Nasdaq dealers flouted trading rules and that the NASD board has been a closed club dominated by the large dealer firms it is supposed to regulate. The report, 400 pages including exhibits, is not due to be made public until Tuesday.
The seven-member committee was led by former New Hampshire Sen. Warren Rudman, who in an interview Friday said, “I think what we’ve done is creative and major.”
But Rudman declined to discuss any of the details. Until the report is released it will remain unclear how far it actually goes to address the problems that led to the committee’s formation.
Nasdaq, unlike the New York Stock Exchange or the American Stock Exchange, has no trading floor. It consists of a network of more than 500 dealers, linked by computer terminals. The stocks of some of the nation’s fastest growing companies are listed on Nasdaq, including high technology giants such as Microsoft Corp., Apple Computer Inc. and Intel Corp.
The NASD appointed the committee last November under strong prodding from Securities and Exchange Commission Chairman Arthur Levitt. It came three weeks after a series in The Times detailed an apparent pattern of trading violations by Nasdaq dealers, including rampant late reporting of trades, failing to honor quoted prices, and harassment of dealers who broke ranks to improve prices to small investors.
Both the SEC and the Justice Department’s antitrust division are conducting investigations of Nasdaq and the dealers. The Justice Department inquiry is concentration on alleged collusion among dealers to fix the prices of Nasdaq stocks. The Rudman Committee was not asked to look into the collusion allegations, but to address only issues of “governance” and the way the NASD’s rules are enforced.
By making public and acting on the Rudman report before the federal investigations are completed, the NASD hopes to be seen as moving to deal with its problems before being forced to do so by federal agencies. But the SEC and possibly the Justice Department are expected to come out with a call for major rule changes, and as reported the SEC is expected by the end of the year to file an enforcement case against the NASD for failing to properly supervise the Nasdaq market.
The Rudman report is said to call for tougher enforcement of trading rules, particularly relating to late reporting of trades. NASD rules require the public reporting of trades within 90 seconds, to ensure that investors have accurate, current information on stock prices. Until a sharp decline after the issue was raised publicly late last year, about 5% of trades on Nasdaq were reported late, compared to a small fraction of 1% on the NYSE.
The committee is said to have decided against suggestions by some critics to separate the NASD from Nasdaq. The critics have charged that there is a basic conflict of interest in the NASD both regulating and running Nasdaq. But officials said the report calls for a big boost in the number of independent representatives on the NASD’s board. Currently, the NASD’s 26-member board has only five public members. In contrast, the NYSE, American Stock Exchange and other stock exchanges have long had a higher outside representation on their boards. The NYSE’s 25-member board has 12 outside directors.
John Coffee, a Columbia University law professor and expert on securities law, said bringing in more outside directors may help the NASD take important steps that big dealer firms so far have forced it to shy away from. For example, under pressure from the SEC, the NASD staff had proposed a new system for handling small customer orders that gave small investors a chance at getting better prices for Nasdaq stocks. But under pressure from the dealer firms the NASD backed away from important parts of the proposal.
Some institutional investors, maverick Nasdaq dealers and others had criticized the Rudman Committee for not holding any public hearings. In addition, they noted that two of the seven committee members are lawyers associated with law firms that are representing big Nasdaq dealers both in the Justice Department antitrust investigation and in a massive private class-action lawsuit brought by investors.
The two are Rudman, now a partner with New York law firm Paul Weiss Rifkind Wharton & Garrison, which represents Nasdaq dealer firm Cantor Fitzgerald, and A.A. Sommer Jr., who although officially retired remains active with the law firm Morgan Lewis & Bockius, which represents Mayer & Schweitzer, the giant Nasdaq dealer owned by Charles Schwabb & Co.
Rudman denied that there is any conflict of interest and said the two law firms had erected “Chinese walls” so that his and Sommer’s work would be kept entirely separate from their firms’ work for the dealers. He also said the committee’s work was extremely thorough, interviewing more than 200 individuals, and said he saw no need for public hearings. In an interview in July he said, “We don’t want to start a debate about what we’re doing that would interfere with our work.”
However, it remains to be seen whether the report will recommend some steps investors groups and, in private conversations, SEC officials, have said they favor. These would include creation of an audit committee of the NASD’s board that would report only to the outside directors, and a fundamental change in the NASD’s procedures so that the NASD’s disciplinary committees are not dominated by traders. Currently, panels that review alleged trading violations by Nasdaq dealers are made up mostly or exclusively of fellow traders. The NASD has rarely taken action against traders at large dealer firms.
