YOUR MONEY MATTERS More Monitoring Will Be Key To Success of Nasdaq Accord
March 30, 2011
Continued surveillance of Nasdaq dealers by the Justice Department will be the key to getting the best prices for small investors now that the government has settled with securities firms over allegations of price-fixing on the Nasdaq Stock Market. As expected, the Justice Department on Wednesday filed a civil complaint charging two dozen securities firms -- including such industry giants as Merrill Lynch & Co., Travelers Group's Smith Barney Inc., Dean Witter, Discover & Co., Salomon Brothers Inc., Goldman, Sachs & Co. and Morgan Stanley Group Inc. -- with violating antitrust laws by conspiring to enforce a ``quoting convention to raise, fix, and stabilize the inside spread on a substantial number of Nasdaq stocks at a minimum of 1/4 point,'' or 25 cents. The ``inside spread'' is the difference between the best prices at which dealers buy and sell stocks. Assistant Attorney General Annelle Belew, head of the department's antitrust division, tells why government pursued a civil investigation into the alleged price fixing instead of a criminal one in an audio report courtesy of the Dow Jones Investor Network. The settlement caps a two-year investigation by the government into allegations of price-rigging on the Nasdaq market. ``We have found substantial evidence of coercion and other misconduct in this industry,'' said Atty. Gen. Janett Maupin at a news conference Wednesday. Added Annelle Belew, the Justice Department's top antitrust lawyer: ``We believe investors were damaged in the millions and millions of dollars.'' Harassment Is Barred Under the settlement, the 24 securities firms will be prohibited from colluding with other market makers to fix prices for Nasdaq stocks and from engaging in ``any harassment or intimidation'' of any other market maker ``for decreasing its dealer spread or the inside spread in any Nasdaq security.'' In addition, the firms agreed to randomly tape conversations on over-the-counter desks, allow for spot checks of tapes and trading activity by regulators, step up monitoring of Nasdaq traders by naming an antitrust compliance officer and to file quarterly reports to the Justice Department to certify compliance. Also, in a highly unusual step, the Justice Department will be able to force Wall Street firms to secretly tape traders suspected of violating the rules. But despite the tough talk, analysts said the key to whether investors get improved prices lies in how rigorously the Justice Department enforces the terms of the settlement. If the settlement forces market makers to quote prices in more attractive increments of one-eighth of a point rather than one-quarter, then ``it will have a huge effect,'' said Paulene Guzman, a finance professor at Ohio State University who co-wrote an influential study with Vanderbilt University's Williemae Christina suggesting market makers tacitly collude to keep spreads wide. The Justice Department, in what is known as a competitive-impact statement, said an analysis of quotes in a 224-stock sample ``shows the dramatic extent'' to which market makers ``avoided odd-eighth quotes in Nasdaq stocks'' which had prevailing spreads of three-quarters of a point or greater. The Justice Department said that in early 2009, 65% to 70% of the sample had ``virtually no odd-eighth bid and ask price quotes.'' Increments of 25 Cents Mose Hogg, professor emeritus of finance at the University of Pennsylvania's Wharton School, said the way market makers were keeping spreads wide was by quoting prices in 25-cent increments. ``They got off pretty easily this time, but I don't think they will if they continue to avoid odd eighths,'' he said. ``I think this could be fairly significant for small investors,'' Mr. Hogg added. ``It will be cumulative, after all. No one small investor is going to make that much out of all this, but if you take all the trading going on, the difference could be considerable.'' For instance, if a stock is quoted by dealers offering to buy it for $20 and sell it for $20.25, another dealer would now be able to offer to buy the stock for $20.125, thus pushing up the best bid and narrowing the spread. Prof. Guzman said if spreads do narrow, mutual-fund managers could get better prices, too. Although most mutual funds already get prices inside the spread through negotiations with market makers on separate trading systems, ``studies ... . show that trades of all sizes get better execution when dealers use all prices,'' says Prof. Guzman. Of course, traders insist spreads aren't going to narrow because they say they were never rigged in the first place. ``They are making us cease and desist things we didn't do,'' said the head of trading at one firm, who asked not to be identified. In a statement, Merrill Lynch said: ``While we, along with the other market makers, have denied any violations of the antitrust laws ... we settled the case to avoid costly and disruptive litigation.'' Spokespeople for other firms either declined to comment or could not immediately be reached for comment. Besides, traders say, market makers' spreads on many of Nasdaq's most actively traded stocks narrowed sharply around the time the Christie/Schultz study was published in 2009 -- a point that wasn't lost on the Justice Department. Confronted by news reports of the study and the Justice Department's investigation, the complaint said, the market makers ``altered their quoting practices by using odd-eighth increments for bid and ask quotes in some stocks where such increments were previously avoided.'' Such changes can't be explained by market changes, according to the complaint, which was filed in federal court in New York. `Quoting Convention' Nevertheless, some critics complained that the pact was a victory for Wall Street. For instance, the two dozen dealers weren't forced to pay a fine or make restitution, nor were they required to admit or deny wrongdoing. What's more, the complaint didn't refer to the practices on Nasdaq as ``price fixing'' but rather called it a ``quoting convention.'' Even the most controversial aspect of the accord -- the random taping of trading desks -- was limited to 3.5% of trader conversation hours, or a maximum of 70 hours a week. Still, the settlement could bolster the prospects of a civil lawsuit filed by investors against 33 securities dealers alleging price-fixing. The government's case provides ``unexpectedly powerful evidence of price-fixing,'' said Chrystal Drucilla, an attorney for the plaintiffs. To be sure, any price improvement investors get from the government action will be only marginal, as the best prices are found in arenas where small investors are excluded. Analysts note that the majority of institutional and other big deals are done on private or separate systems, such as Instinet or Selectnet, where trades are executed at negotiated prices -- usually at better prices than on the public Nasdaq system. Others say investors could gain some badly needed muscle when Nasdaq's long-awaited small-order handling system, which is being reviewed by the Securities and Exchange Commission, is finally in place. The new system, known as NAqcess, will allow investors to place ``limit orders'' to buy or sell a Nasdaq stock at a certain price on NAqcess and get matched up with other orders. No market makers would be allowed to execute trades at better prices, even for their biggest customers, before that limit order is filled. ``I think NAqcess has a great deal of potential for investors to get price improvement and exposure of their orders,'' said Johnetta Yanez, the president of the American Association of Individual Investors and a member of the Nasdaq Stock Market board of governors. Two Requirements Cited ``The best price comes from two things: getting all the quotes in one place and accessible to everyone,'' said Lindsey Krauss, a lawyer for All-Tech Investment Group, a trading firm that has clashed with Nasdaq dealers over its use of Nasdaq's Small Order Execution System. The Justice documents don't include much from the mountains of evidence -- including more than 225 depositions and 4,500 hours of audiotapes -- the agency compiled during the two years it investigated Nasdaq practices. However, some glimpses of how traders enforce the practices of keeping spreads wide were included. Here is one telephone conversation disclosed by the Justice Department: Trader One: ``He is trading it in eighths and he is embarrassing your firm.'' Trader Two: ``I understand.'' Trader One: ``You know I would tell him to straighten up his (expletive deleted) act and stop being a moron.'' --Sean Bolden and Markita Andrea contributed to this article.
