Despite 'spread' probe, Nasdaq remains safe

SUNDAY OUTLOOK

October 30, 1994|By David Conn

The Nasdaq stock market, an electronic, worldwide equity market that last year traded more than $1.3 trillion worth of stock, has come under fire. This month the U.S. Justice Department launched an investigation into charges that the so-called "market makers" who run the trading in specific Nasdaq stocks have conspired to maintain higher than necessary price markups, or spreads.

The same allegations were made in a series of federal lawsuits filed earlier this year that named dozens of securities firms as defendants, including several Baltimore-based companies. Similar charges were advanced earlier in a critical study of Nasdaq by professors at Vanderbilt and Ohio State universities.

Given the questions surrounding Nasdaq, which is administered its own regulator, the National Association of Securities Dealers Inc. (NASD), is the market a good place for small investors to trade?

David S. Ruder

Former SEC chairman,

Northwestern Univ. law professor

Absolutely yes. Nasdaq offers an investment opportunity in the growth stocks that have really been the heart of America's progress. The market includes a small order execution system, by which the investors can have speed and certainty when they invest.

The question of spreads is one which has not been proven, is based upon allegations made in one case by a group of brokers who are having a fight with the NASD, and in another case based upon some studies by two professors which are certainly not conclusive.

I happen to think personally, and I've been very close to this, that the NASD market is an excellent market for small investors.

David A. Lipton

Professor of law,

Catholic University of America

If the system is working properly it shouldn't make a difference where an investor trades.

Broker-dealers are under a fiduciary obligation to customers to obtain "best execution" for their customers. Best execution typically includes best price, but it might be impacted by other issues as well. All brokers have at their disposal these information retrieval systems, and they also have mechanisms for transmitting customer orders to the market with the best price.

That's if the system is working well. There are incentives that play on brokers to at times operate in a manner that does not produce best execution for the customer. Those incentives can include time efficiencies and conflicting remunerations to the broker. If the broker is impacted upon by these competing motivations, it's possible for the customer to end up with other than the best execution. I don't believe that there's any evidence that suggests that brokers who transact business primarily in the over-the-counter market, or in the Nasdaq market are impacted upon by these competing motivations any more than any other brokers.

There is evidence that the spreads between the buy and sell price offered for securities are greater in the over-the-counter market, on average, than in exchange-listed securities. The significance to a customer of these greater spreads is that a greater percentage of a purchase or sale price will be going to the trader of the securities, to the detriment of the customer.

Trading on Nasdaq for small investors probably provides a greater percentage of profit for dealers, because of the greater spread, than would trading on a comparable exchange, but by a very small margin.

We are really talking in terms of pennies, because the best spreads on the exchanges are an eighth of a point while the best spreads on the Nasdaq are typically a quarter of a point, and that represents a difference of 12.5 cents per share.

Andrew M. Brooks

Head of equity trading

T. Rowe Price Associates Inc.

The answer is absolutely. Investors need to employ a good broker, a broker they trust. They should be buying stock in good companies. And they should be price sensitive. NASDAQ is a well-regulated marketplace. It is a marketplace generally of smaller, higher-risk companies, but with higher risk comes higher returns.

There are larger spreads in the over-the-counter market, and that's because it's a dealer market, and dealers are at risk, and dealers should be compensated for the risks they take. Just because spreads are larger it doesn't mean investors have to pay those spreads. You can operate in the middle of the spread.

For example the spread on T. Rowe Price today [Thursday] is 31 1/4 to 31 3/4 -- you could put an order in the middle of that market. The spread's not excessive; that's a little over 1 percent.

Overall, I think Nasdaq can be a very rewarding place to invest for individuals. And I think the key is that you employ a broker that you trust, you buy stock in good companies, and you be pricey. And if you can do that, the investment should stand on its own merits.

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