Allegations of Stock Price Manipulation Anger Buyers

The Justice Department’s surprise allegation that Nasdaq dealers directly--and illegally--manipulated basic stock prices drew angry reactions Thursday from institutional investors and others who regularly buy Nasdaq stocks.

Some criticized the Justice Department, which included the new allegations in court documents filed Wednesday in the settlement of its antitrust suit against 24 Nasdaq dealers, for not taking stronger action against dealers and individual traders.

Holly A. Stark, head trader for the New York money management firm Dalton Greiner Hartman & Maher, called the allegations “chilling.” As did others interviewed, she said the type of conduct alleged had long been suspected, but there had been no hard evidence until the Justice Department disclosed it had documented numerous instances in tape-recorded phone conversations.

Investors and academics said the new allegations go significantly beyond the core charge against the dealers in the Justice settlement: that dealers colluded to keep “spreads”--essentially, their profit margins--no lower than 1/4 point, or 25 cents, on Nasdaq stocks, regardless of the basic stock price.

The new allegations contend that dealers also conspired to temporarily raise or lower the basic price of individual stocks, to benefit the dealers at the expense of unaware customers. The Justice Department said the 4,500 hours of taped phone conversations that it subpoenaed from traders contain “numerous examples” of this.

Paul Schultz, a finance professor at Ohio State University who is a coauthor of a 1994 study that touched off the Justice Department investigation, said the significance of the new allegations is that not only were customers being overcharged on the amount dealers kept for themselves in each stock transaction but also that the prices investors were paying had been artificially manipulated and did not reflect true market demand.

In an interview Thursday, someone close to the government’s investigation, who spoke only on condition that he not be identified, said there were “dozens and dozens” of cases of dealers’ calling colleagues at rival firms and getting them to change a quoted stock price. “It apparently was very routine for traders to make those kinds of requests,” this source said.

In the court documents, the Justice Department says it has evidence of direct price manipulation by some but not all of the 24 firms, and it did not identify which ones.

Michael Murphy, senior vice president and director of trading at Morgan Grenfell Capital Management in New York, a large pension and investment fund manager, said that if the new allegations are true, “it makes me very angry.”

Murphy said there has long been a relationship of trust between investors who buy stocks and the brokerage firms that sell them. “I think that’s been terribly damaged if in fact this happened,” he said.

Catherine A. Ludden, a lawyer for Charles Schwab subsidiary Mayer & Schweitzer, a major Nasdaq dealer, noted that the settlement did not require the dealers to admit wrongdoing. And the dealers continue to deny any.

“None of the allegations in [the documents] are proven fact, and they are all disputed and denied by the dealers,” Ludden said. There are legitimate reasons, she said, that one dealer might call another to request a change in a quoted price.

The new allegations appear to have been included in the Justice Department’s investigative report almost as an afterthought. They are buried on Page 47 of the government’s “competitive impact statement,” in a section on “other unlawful conduct.”

The department decided not to include the allegations of price manipulation in the civil complaint it also filed in court. It said it was not necessary to include them because the settlement the dealers agreed to on the main charge would also prevent such violations from recurring.

The settlement requires the big brokerage firms to randomly tape traders’ conversations and it allows for close monitoring by the Justice Department.

Anne K. Bingaman, head of the Justice Department antitrust division, declined to answer any questions about the department’s decision not to take specific action in response to the allegations of price manipulation.

Each Nasdaq stock has several dealers. Nasdaq rules require that each must offer its customers the best publicly quoted price listed by any of the dealers. The rules are intended to guarantee that customers get the best quoted price no matter which dealer they happen to use.

The source described the type of collusion captured on tape:

In a stock with just a few market makers, two might simultaneously be offering the same lowest price at which dealers are offering to sell to their customers. One of the two might have a customer interested in buying 1,000 shares. That dealer would ask the other to raise its quoted price. Then the requesting dealer would be able to raise its own quoted price as well and sell the stock to the customer at the higher price--pocketing the difference for itself.

Why would the second dealer comply? In the expectation, according to the Justice Department, that the favor would be returned.

In other instances, the source said, such manipulation occurred to create the impression that there was more demand for a stock than there really was. In still others, the department was not able to figure out the purpose.

The source said the Justice Department decided to leave the matter to the Securities and Exchange Commission, which has been conducting an independent investigation. The SEC is expected soon to file administrative charges against the National Assn. of Securities Dealers, Nasdaq’s parent, accusing it of failing to supervise the market.

Rep. Edward J. Markey (D.-Mass.) called Thursday for the Securities and Exchange Commission, which has been conducting a separate investigation of Nasdaq, to fully investigate the alleged price manipulation.