Citing convoluted language, the use of difficult formulae and a need for more testing, several Nasdaq trading firms have slammed the National Association of Securities Dealers' proposed new standards for primary market makers.
With the advent of the order handling rules, the original standards were shelved because old market-maker evaluations were unreliable. One standard, for instance, required market-maker spreads to be no greater than 102 percent of the average spread.
But it was practically impossible to measure when a market makers' quote change was driven by a customer order, entered and later canceled without an execution, making it difficult for desks to meet the 102 percent parameter, according to one major trading desk.
Since the order handling rules, all market makers have been designated primary market makers. The NASD's effort to impose new standards, however, is facing stiff opposition from some firms. Firms have complained about insufficient time to conduct independent analyses, and have expressed trouble understanding the NASD's primary market-making criteria for net-liquidity ratios, proportionate volume and proportionate trades.
Extended Comment Period
The NASD extended the public-comment deadline for the standards from May 1 to the end of May. In comment letters filed with the Securities and Exchange Commission before May 1, several firms blasted the NASD.
Wall Street investment-banking giant Morgan Stanley, Dean Witter, Discover & Co. urged the NASD to withhold approval of its pilot program for the new standards until the NASD submitted "clarifying language to assist firms in making an independent evaluation of its [primary market-making] status, and provide member firms with an initial analysis of its [primary market-making] status on a stock-by-stock basis."
"Until we have a better understanding of the impact of the proposed amendments, we are unable to provide more substantive comment," the letter noted.
Morgan Stanley said the new standards, as drafted, were onerous and difficult to calculate. In addition, the limited comment period and the immediate effectiveness of the technical proposal did not afford members sufficient time to comprehend the consequences of the amendments.
Favors Small Minority
Jersey City-based M.H. Meyerson & Co. stated in a comment letter that the NASD proposal was "blatantly slanted in favor of a small minority of market makers."
In a follow-up letter, the firm linked the proposed standards to another NASD proposal for an integrated order-delivery and execution system.
"The feature of sponsored access [to the limit-order book] by non-members in itself is a terrific concept, provided it is not tied to primary market status," the Meyerson letter noted. "We implore you to use this recommendation without any status modifiers."
"In essence, the NASD has asked that the SEC approve a major restructuring of Nasdaq without affording the public sufficient time to understand, comment or test the proposed changes," stated a CS First Boston letter. More time was needed for industry participants most affected by the changes to "review and reflect" the proposed amendments, the letter added.
Plain English
New York-based CS First Boston was upset with the convoluted language of the NASD's proposal, and urged the association to consider an SEC initiative requiring brokerages to disclose invesment information to investors in understandable English. The investment-banking giant noted that the NASD's proposal requires "multiple footnotes to explain essential, yet perplexing phrases."
"While we understand the concerns raised by the SEC and the NASD regarding the need for more meaningful criteria for the designation of [primary market-making standards] and the concomitant exemption from the short-sale rule, we are very uncertain whether the proposal is the proper way to achieve this goal," noted a letter from Wall Street investment-banking giant J. P. Morgan & Co.
J. P. Morgan worried that the relatively complex formulae appear to require primary market makers to accept significant risks in times of severe market conditions.
"While it does not seem particularly improper to expect a market maker to satisfy its proportional share of trading in an up or down market to be deemed a primary market maker, requiring a minimum arbitrary level of trading against the trend of buying or selling may prove especially harsh in certain circumstances, potentially imposing significant risk on market makers," the J.P. Morgan letter added.
The new standards would also require a market maker to "engage in significant levels of such putative liquidity-building transactions while being limited in its ability to sell short in a down market," J. P. Morgan noted.
Consequently, a market maker trying to buy in a down market would be unable to first sell short to position itself to buy that stock. Thus, the market maker would have to buy first, hoping to sell before the market fell further, potentially making qualification as a primary market maker quite risky.
An NASD spokesman told Traders Magazine that the comment period was extended so industry participants could read and comment on the materials published.
