Study: Nasdaq Traders Still Face Cost Issues
Despite the Nasdaq Stock Market’s multiyear effort to make itself more competitive, investors still are likely to get better prices when they trade New York Stock Exchange issues than Nasdaq issues, a new study concludes.
But the report by the Securities and Exchange Commission also said small investors’ orders are likely to be executed quicker on Nasdaq than on the NYSE.
Nasdaq immediately questioned the report’s methodology, arguing that it was narrowly focused and didn’t account for the vastly different types of companies on the two markets.
The SEC report, released Monday, updates the central issue that triggered massive Nasdaq reforms in the late 1990s, after the government accused the brokerages that operate on the electronic market of colluding to set stock prices artificially high.
The charges led to a restructuring of Nasdaq that imposed stiff rules designed to ensure the fair handling of small investors’ stock orders. Civil lawsuits stemming from the government’s investigation resulted in a $1-billion settlement between brokerages and investors.
Unlike the situation then, the new SEC report doesn’t accuse Nasdaq of any wrongdoing. Many experts, pointing to improvements in the Nasdaq system in recent years, say the trading-cost disparities now may simply reflect the fundamental difference in how the two markets operate.
The trading-cost issue isn’t a reference to commission charges but to the “spread” between stocks’ bid and asked prices in the markets. The bid price is the highest price buyers are willing to pay at a given moment, and the asked price is the lowest price acceptable to sellers.
The SEC study found that in all but the very largest stocks, spreads on Nasdaq stocks are wider by an average of 5.7 cents to 11 cents more per share than spreads on comparable NYSE stocks.
An investor buying 300 shares thus could pay as much as $16.50 more on Nasdaq than on the NYSE for a similar stock.
The study looked at trading in 221 stocks on each market during the first full week of June and focused on orders of between 100 and 499 shares on both markets.
In the very largest stocks, the study concluded, trading costs are “nearly equal” with Nasdaq actually holding a slight advantage. But for the majority of stocks studied, the NYSE offered better prices.
The rival markets are different in many ways, but a key determinant of price spreads is how often buyers and sellers meet directly versus how often a middleman facilitates trades.
On the NYSE, buy and sell orders are matched directly more than 70% of the time. On Nasdaq, by contrast, almost all orders are handled by a brokerage acting as an intermediary.
The spread is, in effect, profit for the brokerage handling the trade.
Because NYSE investors are mostly matched directly on the exchange floor, there is a good chance for the seller of a stock to find potential buyers who are willing to bid up the eventual sale price. In market parlance, that’s known as price improvement.
On the electronic Nasdaq market, however, there is much less opportunity for price improvement. The brokerages intervening in trades typically execute orders at the prevailing market price, with little incentive to look around for other investors who might be willing to pay an improved price.
Indeed, the study found that the potential to secure better prices on Nasdaq is “substantially limited,” outgoing SEC Chairman Arthur Levitt said in a speech at Stanford University on Monday.
Levitt stressed that he was not trying to “indict or endorse” either market, but experts said the study was intended in part to apply pressure on Nasdaq to find a way to lower spreads further.
Levitt, the long-serving SEC chief who said last month that he would step down by mid-February, has repeatedly harped on the issue of hidden trading costs.
Still, there is wide agreement that Nasdaq spreads have come down markedly since the market imposed new rules on brokerages in January 1997.
Nasdaq said Monday that spreads have come down by more than 75% in that time. Experts also noted that enhancements already proposed for Nasdaq’s system in 2001 could make trading even more price-efficient.
“While [the study] is not good for Nasdaq, these numbers are much smaller than you would have seen five or 10 years ago,” said Bill Christie, a Vanderbilt University finance professor, who coauthored a seminal 1994 study that sparked the uproar over Nasdaq trading costs.
Nasdaq officials criticized the study, arguing that it did not accurately reflect the numerous factors involved in good trade executions. They maintained that Nasdaq excels at key factors such as execution speed and liquidity, the term applied to the ability to quickly execute a trade at a generally desired price.
“Any conclusion as to which market is superior [based on] simply focusing on one factor would be the wrong thing for investors to take away from it,” said Richard Ketchum, president of the Nasdaq Stock Market.
He noted that the study gave Nasdaq the edge in terms of speed of execution: Orders of 100 to 499 shares were done in 3.4 to 7.8 seconds on Nasdaq, much faster than the 15.8 to 26.5 seconds it took to complete a NYSE trade, the study found.
With regard to price spreads, Nasdaq maintained that the makeup of companies on the two markets are very different, with Nasdaq home to younger companies with far more volatile stocks.
About half of the difference in the spreads is attributable to the far higher volatility of Nasdaq stocks, Nasdaq claimed. For its part, the SEC said it tried to factor volatility issues into its study.
