SEC Comes Down Hard on Parent of Nasdaq
The Securities and Exchange Commission on Thursday took its harshest action ever against a stock exchange, disciplining the parent of the Nasdaq Stock Market for allegedly looking the other way as big Wall Street firms colluded to boost profits by harming customers.
Capping a 19-month investigation of the nation’s busiest stock market, the SEC filed disciplinary charges against the National Assn. of Securities Dealers, and it simultaneously announced a settlement in which the NASD neither admitted nor denied wrongdoing.
A lengthy SEC report that accompanied the charges also sharply criticized Nasdaq dealers for allegedly flouting trading rules and conspiring against customers in ways that hadn’t been previously disclosed.
The SEC report cites and strongly backs up the findings of a Los Angeles Times investigative series, published in October 1994. The series reported that Nasdaq dealers, including many of the biggest Wall Street brokerage houses, flouted basic Nasdaq trading rules but were almost never punished. These included rules obliging dealers to honor publicly quoted prices and to report trades on time. The series led to the SEC investigation.
At a news conference, SEC Chairman Arthur Levitt said: “The NASD did not fulfill its most basic responsibilities. It simply looked the other way.”
Experts said the settlement should help individual investors by assuring that existing trading rules can no longer be flouted. “Absolutely it helps,” said Michael Murphy, director of trading at Morgan Grenfell Capital Management in New York.
But of even more importance is a series of new rule proposals the SEC has made and is expected to announce in final form soon. Those rules for the first time would give small investors access to better prices that previously only the dealers themselves and big institutional investors could get.
The SEC’s goal is to drastically reform Nasdaq, so that customers will have a much greater chance to trade with each other, rather than having to deal only with middlemen (the dealers).
The SEC’s report wasn’t released until late Thursday, meaning institutional investors and academics hadn’t seen it and couldn’t comment on how far it would go toward achieving that goal.
But the unusual harshness of the language in the report appeared to signal that the SEC is committed to seeing the reforms carried out.
Some of the reforms have already been implemented as a result of a major reorganization the NASD made in response to recommendations last year by an independent committee led by former Sen. Warren Rudman.
But the SEC settlement puts teeth into Rudman’s recommendations, making it mandatory that they continue to follow them. These include steps such as putting a majority of non-dealer public representatives on all of the NASD’s boards of directors and major committees.
While the administrative charges were filed only against the NASD, William McLucas, the SEC enforcement director, said the investigation is continuing. Sources made clear that dealer firms and individual traders are likely to face SEC disciplinary action as well. The harsh and detailed findings are also expected to hurt 33 of the largest dealers in a private class-action lawsuit filed by investors in federal court in New York.
The SEC settlement followed marathon bargaining in which the NASD and lawyers for big firms sought, mostly unsuccessfully, to tone down the agency’s findings.
Officials of the Washington-based NASD on Thursday declined to answer questions. In a news release, the organization said it had already taken major steps to change its operations. “We believe these changes effectively address the issues raised” by the SEC, it said.
Levitt said the strong remedial steps dictated in the settlement, as well as pending rule changes proposed by the SEC, will greatly improve the chances of small investors getting fair prices.
Nasdaq, also known as the over-the-counter market, has experienced explosive growth in the last 10 years. The network of more than 500 dealers, linked by computers and telephones, has become the nation’s second-biggest stock market and has the largest average daily trading volume. Daily volume lately has sometimes surpassed 600 million shares.
Each Nasdaq stock has multiple dealers who stand ready to buy or sell at publicly quoted prices.
Among other steps, the NASD, in lieu of a fine, will be required to spend $100 million to step up enforcement of trading rules. It is required “to improve substantially” the reliability of public reporting of Nasdaq trades and adopt a rule forbidding any cooperation between traders in rigging profit margins or stock prices. The SEC also requires the NASD to hire an outside consultant approved by the agency to make sure the NASD complies over the next three years with all terms of the settlement.
Citing tape-recorded conversations of traders and other evidence, the SEC’s report strongly supports what since early 1994 has been the major public allegation against dealers: that they inflated individual investors’ trading costs by colluding to widen spreads. Those spreads, essentially dealers’ profit margins, are the gap between the price at which a dealer offers to buy a stock and the higher price at which it offers to sell. Spreads on Nasdaq have been much wider than is typical on the New York or American stock exchanges.
The SEC said top NASD executives had evidence of such collusion beginning in 1990 but failed to act.
But the SEC’s 157-page report also outlines wrongdoing by dealer firms that hadn’t been documented before, or had only been alluded to in a report issued by the Justice Department last month, when 24 big dealer firms agreed to settle civil antitrust charges.
For example, it found that dealers routinely shared information with each other about a customer’s orders, including the size of the order and the customer’s identity. The SEC alleged that in many instances, if a customer had a large order to buy a stock, the firm that received the order would tip off other firms. It said the purpose was to enable them all to raise their prices and get higher profits from the orders at the expense of customers. Such customers included big mutual funds.
Dealers also manipulated basic stock prices and gave each other important information not available to customers that was likely to influence the price of a stock, the SEC found. It cited an example of a dealer firm telling other dealers that it planned to take a stock off its “recommended buy” list and would soon be selling large numbers of shares.
“Numerous [dealers] collaborated without disclosure to their customers in ways that misled and disadvantaged their customers,” the SEC report says.
Several of the leading dealer firms declined to comment on the allegations. Smith Barney, a unit of Travelers Group, said, “We remain committed to Nasdaq and particularly to the high standards we enforce in our trading and market-making practices.”
The report also vindicates a handful of small maverick firms, including All-Tech Securities in New Jersey, that had tried to narrow spreads. These firms contended that they were subject to harassment and retaliation by other dealers and the NASD itself. The SEC said such harassment in fact was widespread, and it ordered the NASD to take steps to eliminate it.
Under federal law, the NASD is required to police Nasdaq and enforce securities regulations. But the SEC found that it not only failed to take disciplinary action, but added to the wrongdoing itself.
For example, the SEC said the NASD staff launched “a concerted effort” to bring disciplinary proceedings in retaliation against small firms that cut spreads, instead of filing cases against big firms that violated basic trading rules.
It also found that the NASD, instead of disciplining dealers that reported trades late, took steps to help them cover up the late reporting. In one example, the SEC said, a tape recording captured “an NASD Market Surveillance supervisor inappropriately [instructing] a trader to submit an inaccurate trade report.”
Although it harshly criticized the NASD, the SEC didn’t single out any individual executives, and none are expected to be charged. Despite a major NASD reorganization made in response to the investigations, many top executives remain in their posts.
Times staff writer James Peltz in Los Angeles contributed to this report.
