Nasdaq Dealers Reportedly Settle in Federal Probe

Major dealers of stocks traded on the giant Nasdaq Stock Market reached a tentative settlement Friday with the federal government of allegations that they engaged in a “market-wide conspiracy” to inflate the costs of those stocks, sources said.

Capping a massive government investigation underway since 1994, 24 firms--including well-known Wall Street houses such as Merrill Lynch, Smith Barney, Bear Stearns and Goldman Sachs--have agreed in principle to the settlement with the Justice Department’s antitrust division, sources said.

The 24 include all the firms against which the Justice Department was preparing to file civil charges. They will be subjected to a “consent judgment” entered in court that will require them to take detailed steps to ensure that trading costs are not rigged.

The Justice Department investigation, and a related one by the Securities and Exchange Commission, represent by far the biggest government inquiry into a major stock market since the Great Depression.

Estimates of the harm to investors range well over $1 billion, since if the government is correct, the wrongdoing affected nearly every share traded of the larger companies listed on the Nasdaq Stock Market. Nasdaq has surpassed the New York Stock Exchange as the nation’s largest stock market, as measured by average daily trading volume.

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One source close to the government said the accord was expected to reduce individual investors’ costs of buying and selling Nasdaq stocks by narrowing “spreads”--essentially, dealers’ profit margins.

As is typical in Justice Department settlements of civil antitrust charges, the firms will neither admit nor deny wrongdoing. And as with virtually all such settlements, this one will not involve any fines or damages.

But lawyers for investors said the settlement with Justice greatly increased the possibility that the firms could face major damages in a private antitrust class-action lawsuit filed by investors. The suit, against 33 Nasdaq dealers, is pending in federal court in New York.

Sources cautioned that although a tentative agreement was reached with Justice, several details remained unresolved and could still derail it, although they said this was unlikely.

Gina Talamona, spokeswoman for the antitrust division, declined to comment or confirm that a settlement had been reached. Contacted by phone, lawyers for half a dozen of the major firms said to be included in the settlement did not deny that a tentative accord had been reached, but declined to make any comment on it.

The accord comes about six weeks after the Justice Department told the firms it was prepared to file civil charges and invited their lawyers to look at the evidence in hopes of persuading the firms to settle. Sources said several deadlines imposed by Justice were pushed back, as the dealers had great difficulty agreeing among themselves whether to settle or fight the charges.

In the end, a source close to the government contended, the strength of the Justice Department’s evidence convinced the firms that they would probably lose if the case came to trial. People close to both sides said the firms decided that they would be better off trying to put their legal difficulties behind them.

As reported in a Times investigative series in 1994, the government has been looking into allegations that dealer firms colluded to rig the spreads on Nasdaq stocks, increasing charges especially for smaller investors. A spread is the gap between the price at which dealers offer to buy a stock and the higher price at which they offer to sell.

Most stocks listed on the New York Stock Exchange trade with spreads of only 1/8 of a point, or 12.5 cents. On Nasdaq, by contrast, most stocks--including many of the biggest--until recently almost never traded with spreads smaller than 1/4, or 25 cents.

As part of the settlement, the Justice Department is expected to file a complaint alleging a “market-wide conspiracy to inflate spreads.” At the heart of the government’s case were thousands of hours of taped conversations of traders allegedly discussing fixing spreads and attempting--often in uninhibited language--to intimidate colleagues at other firms who tried to narrow the gap.

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Many firms had routinely taped traders’ phone conversations for future reference in the event of disputes. After the Justice Department subpoenaed the tapes in 1994, most of those firms stopped taping. A key part of the settlement, however, will require the 24 firms to tape all of their traders’ phone calls, sources said.

The settlement also will require the firms not to engage in anti-competitive practices, give the antitrust division wide authority to monitor trading, require the firms to file detailed reports and oblige them to appoint special compliance officers to make sure that all employees adhere to the settlement.

As of the end of May, there were 542 Nasdaq dealer firms, including many very small ones. Justice decided to focus on the biggest dealers and selected the 24 firms because it believed it had the strongest evidence against them, sources said. They said Justice had not completely ruled out the possibility of seeking charges against or a settlement with additional firms.

Sources said the biggest obstacle to a settlement was the fear among firms--including large ones such as Merrill Lynch and Smith Barney--that by signing an accord with Justice they would open themselves up to potentially serious disciplinary action by state securities regulators.

Under some state laws, firms that enter into consent decrees with the federal government could automatically be banned from acting as investment or mutual fund advisors.

It was not entirely clear on Friday how this obstacle was overcome, although lawyers said there were ways the firms could avoid such consequences.

Following The Times series, the Securities and Exchange Commission also launched an investigation of Nasdaq, which focused on other alleged improprieties. These included firms’ refusing to honor quoted prices, denying small investors access to the best prices and deliberately reporting trades late.

The SEC is expected as early as next week to announce a settlement with the National Assn. of Securities Dealers, or NASD, Nasdaq’s parent, involving administrative charges of failing to police the Nasdaq market, along with a detailed report spelling out shortcomings.

The NASD, in response to an independent report it commissioned after allegations of widespread wrongdoing became public, has already undergone major organizational changes and has put more outsiders on its boards of directors.