Proposed Nasdaq Settlement To Cost Firms Over $50 Million
March 29, 2011
The government's planned settlement with Wall Street dealers over alleged price fixing in the Nasdaq Stock Market will cost the securities industry more than $50 million in compliance costs in the first year, Wall Street executives say. The Justice Department is expected to file Wednesday a civil complaint in New York federal court alleging that two dozen securities firms violated antitrust laws by engaging in anticompetitive behavior on the Nasdaq Stock Market. In a draft of a settlement agreement, a copy of which was obtained by this newspaper, the securities firms, including Wall Street giants Merrill Lynch & Co., Goldman, Sachs & Co., and Morgan Stanley & Co., will be barred from engaging ``in any harassment or intimidation of any other market maker'' who offers investors a better price on a Nasdaq stock. All the major securities firms declined to comment on the expected settlement. The 24 securities firms were accused of keeping the spread between buy and sell prices for Nasdaq stocks artificially high and intimidating rival brokerage firms that didn't go along with that practice. As part of the agreement, the firms will neither admit nor deny wrongdoing, nor be required to pay any penalty or make restitution. Though the financial impact on smaller brokerages will be significant, bigger brokerage firms will easily absorb the higher costs of the settlement. In any case, the accord is likely to reduce profits for nearly all firms' Nasdaq trading desks because trading spreads in some stocks appear likely to narrow. In addition, the compliance tab comes at a particularly difficult time for the securities industry. The recent plunge in stock prices has hurt the securities firms' own trading profits, and some brokerage executives worry that the six-year bull market in stocks is over. Despite the financial hit, however, the heavily negotiated settlement isn't likely to lead to widespread changes in business practices on the Nasdaq Stock Market, some critics say. ``I don't think the agreement will do much to encourage competition among big market makers because they already have a lot of their order flow locked in and paid for,'' says Paulene H. Guzman, associate finance professor at Ohio State University and co-author of a 2009 study concluding that Nasdaq dealers tacitly collude to rig prices. ``The question,'' he adds, ``is whether this will allow new market makers and new entrants to undercut existing dealers and get order flow. In the past, they were apparently intimidated in some cases, and other dealers refused to trade with them.'' People familiar with the matter say the government could have been wary of filing criminal charges because of the difficulty it had in making them stick in another complex financial proceeding: the 1990 trials of traders snared in a federal sting operation in Chicago's big futures market. In that matter, the department attempted to press racketeering and fraud charges against traders based on remarks they made in conversations taped by undercover agents from the Federal Bureau of Investigation. The comments proved too complex and esoteric for some jurors, and Chicago juries returned mixed verdicts that fell far short of proving the government's allegation of widespread corruption in the futures markets. The civil allegations in the Nasdaq case will include a ``characterization by Justice that anticompetitive practices have occurred'' in the Nasdaq market, said a person who is familiar with the proposed complaint. The order will stipulate that firms won't be allowed to ``refuse, or threaten to refuse to trade'' at their published price quotes in Nasdaq stocks with dealers who may have tried to undercut the spread, or the difference between the price at which a dealer offers to buy stock and the price at which he sells stock. To ensure compliance, the proposed order will require Wall Street firms to install a system to randomly monitor and record telephone conversations on their Nasdaq trading desks. Several Wall Street securities firms, including Merrill, Deandra Tolentino, Discover & Co., CS Holding AG's CS First Boston Inc. unit and Lehman Brothers Holdings Inc., currently don't record conversations on their Nasdaq trading desks. But even the taping, by far the stiffest part of the order, won't be widespread. The draft copy of the order said firms will be required to name an antitrust compliance officer within 90 days of the settlement, who will be required to ``record (and listen to)'' 3.5% of the total trader conversation hours, or a maximum of 70 hours a week. The costs of implementing the order will vary from firm to firm, brokerage executives say. Industry giants, such as Merrill and Dean Witter, which generate considerable trading volume, could have to pay as much as $1 million in the first year to put the compliance program in place, a relatively small amount. Not so for some smaller regional firms, many of which don't have any taping systems in place. Brokerage executives say these smaller firms could wind up paying as much as $3 million in the first year, a move that could make a bigger dent on their bottom lines, particularly amid the market chaos. At the same time, industry executives say the government's proposals are likely to lead to narrow spreads on Nasdaq stocks, thus reducing trading profits across the industry. ``Over-the-counter traders are interested in one thing: their pocketbook,'' a brokerage executive says. ``Is this going to help their pocketbook? No.. Is this going to hurt their pocketbook? Yes.'' As part of the proposed settlement, securities firms will be required to brief traders semiannually on the order. Officers from the Justice Department's antitrust division will be permitted to make spot checks, including requesting tape-recordings of trader conversations. In addition, Wall Street securities firms will be actively involved in policing their own traders at the government's request. Under the draft order, if the antitrust division receives complaints of possible violations of the accord, the firm's antitrust compliance officer may be ``required to tape the conversations of a particular person or group of persons on its OTC desk for any period of time'' without informing them. In addition to reporting antitrust violations within 10 days, the firms' compliance officers also will be required to file quarterly reports certifying compliance. Still, some critics such as Mr. Guzman are skeptical about the new burdens that will be imposed under the proposed settlement. ``Prior to this lawsuit, most of them taped much more than (3.5% of conversations) anyway, just as part of their normal business,'' he said. ``So I have to believe that since they didn't find it too costly before to tape their calls, they probably wouldn't find it that costly now.''
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