Justice Dept.: Nasdaq Dealers Manipulated Stock Prices

Some major dealers in Nasdaq stocks routinely colluded with each other to directly manipulate stock prices up and down, the Justice Department alleged Wednesday.

The bombshell revelation came as part of the agency’s announcement of its settlement of civil antitrust charges against 24 Nasdaq dealers.

The government said its investigation, which produced tape-recorded evidence, “uncovered numerous instances” of dealers’ agreeing to help rival firms benefit financially by raising or lowering quoted prices.

Until now, the public allegations of wrongdoing concerned collusion by dealers to inflate their profit margins, or “spreads”--the gap between the price at which they offer to buy a stock and the higher price at which they offer to sell.

The allegation of direct manipulation of the basic market prices of stocks was buried in court papers that focused on the settlement of civil antitrust charges of a long-standing conspiracy by the 24 dealers, including the biggest Wall Street brokerage houses, to manipulate spreads. The dealers included Merrill Lynch, Smith Barney, Goldman Sachs, PaineWebber and Prudential Securities. In a settlement expected since last week, the government charged that the dealers had used harassment and intimidation to enforce the conspiracy.

The settlement capped a massive two-year investigation by the Justice Department of Nasdaq. At a press conference, Atty. Gen. Janet Reno contended that the settlement required the firms to take steps that would end the fixing of spreads, even though the accord involves no direct financial penalties.

“This will restore true competition” among Nasdaq dealers, Reno said, adding that the conspiracy had cost individual investors “many millions of dollars.”

The settlement did not require the dealers to admit wrongdoing and, in statements, they strongly denied any violations. They said they had simply settled on what they contended were mild terms to avoid a threatened lawsuit by Justice.

In a statement similar to those issued by other firms, Smith Barney said it “absolutely denies any allegations that it participated in any conspiracy or arrangement to violate antitrust laws.”

The government documents referred to a “quoting convention” under which there was an “essentially market-wide” understanding among dealers that spreads for many stocks would not be less than 1/4 of a point, or 25 cents.

Justice Department Antitrust Chief Anne K. Bingaman said that even though the government believed it had strong evidence that dealers had manipulated spreads, it decided early on not to file criminal charges. She said it made the decision because the conspiracy had been in effect for so long--perhaps 30 years--that it had simply become a way of life on Wall Street. “This had gone on so long it was just like breathing to them,” Bingaman said.

Once the government decided to file only civil charges, she said, the law did not allow it to seek fines, damages or restitution. In civil antitrust cases, the Justice Department can only get court orders stopping the alleged illegal practices and requiring remedial steps.

Although Justice can’t seek civil damages, the firms do face possible stiff financial penalties from a private antitrust lawsuit pending in federal court in New York. The law allows such private suits to seek treble damages, which investor lawyers contend could total in the hundreds of millions of dollars.

Arthur Kaplan, a lead lawyer for investors in the private suit, contended that the Justice Department allegation of a successful market-wide conspiracy greatly helped the private suit, even though dealers did not admit any wrongdoing.

But Catherine Ludden, a lawyer for one of the dealers, Charles Schwab subsidiary Mayer & Schweitzer, denied that the settlement would have any impact on the private case.

Bingaman said the 24 firms named in the Justice settlement together accounted for about 70% of the trading volume on Nasdaq.

She said public disclosure of the allegations and investigations had already had a major beneficial impact. In apparent response to the publicity and investigations, she said, the average spread on Nasdaq stocks had narrowed about 27%.

The settlement means that Justice will not make public the evidence it collected, including 4,500 hours of taped conversations of traders and more than 225 depositions. Investigators have said the tapes contain overt discussions of boosting spreads.

Justice disclosed only one example Wednesday in which a trader called another firm to complain that its trader had narrowed a spread. The other firm, the caller said, should tell its trader “to straighten up his (expletive) act, stop being a moron.”

In response to a question, Bingaman said this was not the strongest example Justice had on tape.

Under the settlement, the firms will be required to randomly tape traders’ conversations and listen to the tapes. Although they will be required only to tape about 3.5% of calls, Justice said this would amount to some 40,000 hours of tape each year. Justice will be allowed to make surprise visits, listen to the tapes at any time and order taping of traders against whom complaints had been made.

Justice is setting up a telephone hotline for complaints against traders. And the firms agreed to be banned from colluding on spreads and from taking any steps to punish dealers that lower spreads. The firms will also be required to file detailed reports with Justice and to take steps to ensure that traders comply with the ban.

Although the Justice Department’s documents contained the new allegations of direct price manipulation, Justice included them only in the “competitive impact statement” it filed with the court and not in the actual charges it filed in a complaint against the firms. Justice stated it was not necessary to file the charges because the remedies ordered to eliminate the alleged conspiracy on spreads would also prevent direct price manipulation.

The Justice Department case represents a vindication of sorts for two business school professors, William Christy and Paul Schultz. In an academic paper in 1994, they reported that Nasdaq dealers systematically avoided quoting stocks with spreads narrower than 1/4, even though spreads of 1/8, or 12.5 cents were typical on the New York Stock Exchange. They said “tacit collusion” appeared to be the only possible explanation.

The Justice Department’s findings also support findings in a Times investigative series in 1994, which reported that wide spreads were enforced on Nasdaq by dealers who threatened and sometimes punished rivals for trying to narrow them.

The Securities and Exchange Commission, which launched its own investigation in 1994, is expected to file administrative charges soon against the National Assn. of Securities Dealers, which operates Nasdaq, for failing to properly supervise the market.