A low-ranking official at the Securities and Exchange Commission recently fired off a public comment letter about the new trading system proposed by the National Association of Securities Dealers.
"The system," said the official rather inelegantly, "sucks."
The comment letter is one of more than hundreds of messages transmitted via e-mail to the SEC by letter writers who landed upon a home page used by the NASD to promote its integrated order-delivery and execution system.
The controversial system has been variously called NODES, Next Nasdaq, New Nasdaq and some other unprintable names. But the unprecedented use of the web by the NASD made name-calling purely academic.
Some investors and Internet surfers were taken aback. For a time, the site prevented a person from viewing other sites unless they e-mailed a comment letter on the new Nasdaq system to the SEC. The NASD was inundated with protests, and the home-page conundrum presumably prompted the uncharitable response from the low-ranking SEC official.
This was a bad start for the NASD's campaign to win support for the integrated order- delivery and execution system, or NODES. But it was a good, if not troubling, reminder of the subterranean depths the debate on NODES has sunk since the proposal was published on the Federal Register for public comment.
The confusing sounds of market makers, electronic communications networks (ECNs), public investors and other voices make this a battle for the history books.
The e-mails poured in from around the world, from as far away as Turkey, and as near as San Antonio, where retired widow Barbara J. Whiting said she was afraid to buy anything on Nasdaq anymore because "the prices are so volatile."
Some writers were enthusiastic about NODES, but not Mrs. Whiting.
"My broker says that this new system may make it even harder to determine [prices] because my order will be competing with brokers, market makers, institutional traders and other public customers," Whiting stated.
"He has told me some of his concerns about not being able to cancel an order for ten seconds, the anonymity of the contra-party and the ability of the market maker to not fill an order and say he's on the phone."
"Before SOES," added the quintessential little trader from way down South, "I wouldn't trade over-the-counter stocks. If this proposal goes through, I probably won't trade on Nasdaq again."
The wording for the NASD's brief message irritated most market makers and drew the attention of several skeptical ECNs. In summary, the NASD said it was asking the SEC for permission to make "exciting new changes to improve what is already the most popular marketplace for American individual investors."
At face value, the NASD's message was as convincing as a blond bombshell purring half-garbed atop a Cadillac Seville in a slick magazine advertisement. Some might view the NODES pitch as tantalizing. Sure, you'll subscribe.
The NASD said NODES would give matching limit orders the potential to be executed automatically without a spread, providing investors with tangible savings.
"These benefits increased visibility and lower transaction costs are just part of what Nasdaq wants to provide to the individual investor through it new system," the message continued.
Sure, how could you possibly resist? Some might, however. The NASD warned that "several groups are almost certain to be opposed to the Nasdaq-backed system."
Reuters Group PLC's Instinet, in its own public comment letter filed via conventional channels, said the NASD message was "hyper-promotional in nature and does not give the public a reasonable basis from which to offer informed comment. If the NASD member firms were to propose describing their services in such glowing terms on their web site, NASD Regulation would likely find such material in violation of applicable NASD regulations."
From the start, the proposal for a new trading system has been resisted by a large group of market makers, in part because a centerpiece of the proposal is a central, or consolidated limit-order book sponsored by the NASD.
Besides the fear of competition from its own self-funded, self-regulatory organization, market makers would likely have to fulfill several primary market-maker standards before they could provide institutional access to the book.
William Sulya, head of Nasdaq trading at St. Louis-based A.G. Edwards & Sons, welcomed most of the NASD proposal, but expressed several reservations.
For one thing, he xechoed a concern xxthat the xNASD's
voluntary limit-order book may become the de facto standard for best-execution obligations. "The apparent efficiency and fairness of the Nasdaq limit-order file would suggest that member firms would be satisfying best-execution obligations by routing orders to the proposed system," he said.
One of the few features market makers and other participants agree upon is the proposal to merge SOES and SelectNet into one system, thus eliminating the current problem of potential double liabilities on transactions.
The other problems raised by critics, thereafter, are numerous. For one thing, ECNs stepped up their attacks on the NASD's proposed system in the public comment letters.
Instinet said the proposed automatic-execution feature for smaller orders would force ECNs to begin assuming proprietary positions.
Bloomberg, which owns the ECN Bloomberg Tradebook, said the new system would likely put ECNs out of the automatic-execution system "because they could not provide automatic-executions to ECN participants without risking double or multiple executions via the new Nasdaq system."
Bloomberg illustrated, with an example, the dilemma ECNs could face:
Customer A places an order in an ECN to buy 1,000 shares of stock at $20 a share, which becomes the best bid in the ECN and is published in the new NASD limit-order book as the Nasdaq best bid.
Customer B, an ECN participant, enters a priced sell order into the ECN for 1,000 shares at $20 with the intention of hitting customer A's bid. Shortly thereafter, customer C enters an order into the NASD system through a dealer to hit customer A's bid.
Though it would appear Customer A is on the line for a double liability two trades, each 1,000 shares in size the ECN, in fact, would have to provide the 1,000 shares to satisfy Customer C's buy order, according to Bloomberg.
"That outcome would likely cause ECNs to exit the execution business because they would have no alternative but to send their participants' orders on an agency basis to Nasdaq. ECNs would thereby cease to be ECNs for orders of 1,000 shares or less within the SEC's definition in the order-execution rules. And then there would be only Nasdaq."
Instinet hinted at a conspiracy by the NASD, raising the possibility that only the top four or five Wall Street firms would be able to fulfill the NASD's proposed primary market-making standards. What's more, Instinet says the primary market-making standards as currently proposed are unworkable as institutions would be required to enter sponsorship arrangements on a security-by-security basis.
"Given that institutional money managers need the flexibility to trade Nasdaq securities at will, this would literally require dozens of sponsorship arrangements with Nasdaq market makers to insure that an institution could trade any Nasdaq security through the system at a moment's notice," Instinet stated.
A.G. Edwards' Sulya urged that the primary market-making standards not be a condition for sponsoring institutions, adding that A.G. Edwards feared this was the first step toward a bifurcated marketplace between institutional and retail investors.
The proposal engaged an Orwellian flight of fancy, according to another comment letter filed by day trader and Rutgers University finance professor David Whitcomb. He was referring to the firm-quote compliance facility, or the so-called phone-ahead button that market makers would press, giving them 17 seconds to take their quote out of the automatic-execution rotation.
"The worst part about the phone-ahead button is that it officially promotes false advertising. Firm quotes ought to be just that: firm and available," Whitcomb stated.
What about the little guy?
"Without meaningful competition," Instinet complained, "Investors would have less flexibility in determining how best to execute transactions in Nasdaq stocks, and be forced to accept the Nasdaq option."
Instinet thinks the little guy will be shortchanged because Nasdaq would be able to set commission rates independent of competitive pressure.
