President Clinton plans to nominate Arthur Levitt to a second term as chairman of the Securities and Exchange Commission. Levitt's current five-year term expires in June. A second term would end in June 2003, and serving the full term would make Levitt the longest-sitting chairman in the SEC's 63-year history.

The nomination must be confirmed by the Senate Banking Committee before receiving full approval from the Senate. Levitt, a former chairman of the American Stock Exchange, championed the interests of small investors during his first term, focusing in particular on tougher oversight for the municipal bond market, Nasdaq and brokerage firms.

John S.R. Shad, who headed the SEC from 1981 to 1987, was the only other chairman to be reappointed. He left office before the completion of his second term to become Ambassador to the Netherlands.

The Association for Investment Management and Research (AIMR) is reviewing members' written responses to a set of soft-dollar standards recently proposed by an AIMR blue-ribbon task force.

As of mid-February, however, only a "handful" of members responded, said Linda Rittenhouse, vice president for advocacy, legislative and regulatory affairs at the AIMR, a Charlottesville, Va.-based trade group representing 60,000 members at buy-side firms using soft dollars.

Still, AIMR's executive board, which created the task force, tentatively plans to present the standards to its board of governors this month. A response period gives members time to comment and suggest changes to the current standards.

Pending approval of the standards which contain both mandatory and voluntary provisions the board will then choose a date to put them into effect and urge members to adopt them.

Ethical Principles

The standards, or ethical principles as the AIMR also called them, include a voluntary statement of compliance for investment managers. The statement would require investment managers to provide their clients with statements vouching that any brokerage arrangements involving clients are consistent with the overall standards.

The task force was created last August, following growing concern over negative public perceptions of soft-dollar practices. The Securities and Exchange Commission conducted its own nationwide sweep last year of firms engaged in soft-dollar practices.

"If we didn't address this, others would have," Rittenhouse told Traders Magazine. "The train was leaving the station without the AIMR on board."

The controversy over soft dollars is rooted in a safe-harbor provision, Section 28(e) of the Securities Exchange Act of 1934, which Congress enacted in 1975.

Section 28(e) was meant to protect investment managers against claims they had breached their fiduciary responsibilities using higher client commissions to acquire investment research.

According to the task force, "a fair amount of legitimate confusion" has been the result. The confusion stems from a considerable expansion in the soft-dollar area, both in actual usage and the types of products and services for which safe-harbor protection is claimed, the task force noted.

Terms of Reference

The blue-ribbon panel had a wide term of reference, probing, for instance, whether soft dollars should actually be eliminated, and if elimination would result in the unbundling of brokerage and research services.

The panel looked at developing uniform definitions, as well as the need for uniform disclosure by an investment manager; the importance of treating proprietary research the same as third-party research; and the need for investment managers and their clients to understand the fiduciary principles in directed brokerage.

The proposed standards define a soft-dollar arrangement as one in which "the investment manager directs transactions to a broker, in exchange for which the broker provides brokerage and research services to the investment manager." Such arrangements include proprietary and third-party research agreements, but exclude client-directed brokerage arrangements.

The work of the blue-ribbon panel was painstaking, of course. Coming up with a practical definition of soft dollars was just one of several challenges.

Despite a tight deadline, the panel made impressive headway, identifying "allowable" research, establishing standards for soft-dollar use, creating "model" disclosure guidelines and providing guidance for client-directed brokerage arrangements.

For example, there are standards relating to relationships with clients. An investment manager would be required to "disclose to the client that it engages in soft-dollar arrangements prior to engaging in such arrangements involving that client's account." The panel recommends that the investment manager "should assure that, over time, all clients receive the benefits of research purchased with client brokerage."

"The AIMR is a very strong voice for industry ethics," Rittenhouse said. "It is incumbent upon us to take the lead in addressing soft dollars. No one has been looking at the issue from the investment-manager's viewpoint."

Cooperation

The task force enlisted the cooperation of the SEC. Douglas Scheidt and Catherine McGuire, chief counsel in the SEC Division of Investment Management, and chief council in the SEC Division of Market Regulation, respectively, participated as observers.

The SEC observers simply acted as "touchstones," according to Rittenhouse. They were consulted, for instance, on whether the panel's work was relevant to the abuses sought in the commission's soft-dollar sweep.

"Other SEC staffers were very helpful, either by raising issues which needed clarification or were overlooked," said Rittenhouse. "But in no way did they try to direct the outcome."

Frustration over the momentous task of implementing the National Association of Securities Dealers' Order Audit Trail System (OATS) may be unnerving both regulators and the trading community.

At press time, however, the current stumbling blocks pushing back the phase-in from August to Jan 1., 1999 under NASD prodding, and deciding the technical specifications look set to be surmounted.

"We are expecting a Securities and Exchange Commission approval [deadline] very soon," Mary Shapiro, head of NASD Regulation, told Traders Magazine in mid-February. In addition, NASD Regulation made it clear that technical specifications would be published on its OATS web page.

Bernard L. Madoff, who chairs the Securities Industry Association's OATS Ad Hoc Committee, said that SEC action by month's end was most likely imminent.

Original Deadline

Nevertheless, preparing for OATs has had industry participants hot under the collar. In particular, the original August deadline for phasing-in OATS which still officially stands, unless the SEC approves the NASD-proposed January deadline has upset many traders.

"We were hit between the eyes with deadlines for the order handling rules, and now we have OATS," said one trader, who declined to be named. "I pray that the SEC approves the new OATS timetable."

Meanwhile, a frustrated Stuart Kaswell, general counsel of the SIA, complained at a press briefing that "you cannot spec out a system without specs."

OATS is envisioned as a real-time electronic system designed to gather and report some 25 Nasdaq trade details. At the moment, Nasdaq desks electronically report certain trade information to the NASD within 90 seconds of execution.

Information

While OATS technical specifications are pending, NASD Regulation has not been slow, however, making information available on the regulatory side. According to material published by NASD Regulation, if a firm is acting strictly in the capacity of an investment adviser and not acting as a broker dealer when recovering or handling orders, there is no reporting responsibility. On the other hand, if a firm receives and/or handles orders in Nasdaq securities, it has OATS reporting responsibilities.

Moreover, if a firm has a reporting responsibility, and it has an arrangement with a clearing firm, it is possible that the clearing firm will report order information on its behalf.

However, the agreement to use another firm must be arranged by the firm with reporting responsibility and supported in written form. The firm must also provide its clearing firm with the information required to be reported.

If a firm has a reporting responsibility, the burden is on both the firm and the submitting firm to ensure that timely, accurate and complete order information is reported. It is a shared responsibility. Member firms using non-member entities are responsible for submissions made by the non-member entities. Some member firms will be required to develop a means for electronically capturing and reporting data on specific events in the life cycle of each order.

Member firms must report oral, written or electronic instructions to initiate a transaction in a Nasdaq security, including orders received from another member firm and orders received from another department within the same firm.

In addition, member firms with reporting responsibility must report the routing of orders to another member firm, another department of the same firm or an electronic communications network, and the modification, cancellation and execution of orders.

All orders must be reported to OATS, including open orders, modified orders, partially-executed orders, canceled orders and expired orders. If an order-entry firm has a reporting responsibility, it must report the new order and the execution.

Market makers must report a new order and execution only if the trade is in response to an order submitted by one of the market-maker's customers, another broker dealer or originated from another department within the firm. If the market maker initiates a transaction for its own account against another market maker, it is not required to report the execution.

Real-time reporting is not a requirement. Member firms that have reporting responsibility will be allowed to send order information to NASD Regulation in a batch file. Members may choose to send one file at the end of the day or several files throughout the day.

Software

There are no plans to provide members with software or a workstation to transmit the required data. NASD Regulation plans a series of industry forums pending SEC approval of the new deadline.

Once available, paper copies of the technical specifications can be requested from NASD Regulation's OATS Support Center at (888) 700-OATS or (301) 590-6503, or via e-mail at oatscsc@nasd.com.

Rick Ketchum, chief operating officer of the National Association of Securities Dealers, has been named president of the association, a title previously held by NASD Chairman and Chief Executive Officer Frank Zarb. In his new post, he will be responsible for a broad range of NASD operations, while continuing in his role as COO, the NASD said in a statement. Ketchum will report to Zarb.

The NASD said that Ketchum will work closely with NASD subsidiaries in the development and formulation of legal, regulatory and market policies, as well as international initiatives. Ketchum joined the NASD from the Securities and Exchange Commission as executive vice president in 1991, and was appointed COO in 1993.

In a related appointment, Salvatore Sodano was named deputy COO. He will continue in his role as NASD chief financial officer.

Separately, John Hilley was appointed executive vice president for strategic development at the NASD, a newly-created post. He will work closely with the NASD's Office of the Chairman, and oversee corporate strategy and planning. He will also oversee state, federal and international government relations. Prior to joining the NASD, Hilley served at the White House as a senior advisor to the President.

The National Association of Securities Dealers is seeking the approval of the Securities and Exchange Commission to allow market makers to quote all Nasdaq stocks in 100-share minimum proprietary trade quotes, J. Patrick Campbell, Nasdaq's executive vice president for market services, told the annual mid-winter convention of the Philadelphia Security Traders Association.

Currently, 150 Nasdaq stocks are subject to an actual-size rule, allowing traders to quote these stocks in minimum trade sizes of 100 shares. The NASD had proposed the elimination of the 1,000-share minimum quote-size rule on all stocks as a natural consequence of the order handling rules. The proposed new Nasdaq trading system, in fact, may hinge on traders being allowed to quote all stocks in minimum trade sizes of 100 shares.

Nasdaq made it clear that if artificial quote-size requirements on all Nasdaq securities are not eliminated ahead of a new integrated order-delivery and execution system, some order-entry features of the facility would not be appropriate.

Campbell said in an interview during a break at the Philadelphia convention that approval of the NASD proposal "will enable a trader to manage the risk, manage the quote, with one more dimension and that's size other than just price."

He added that the SEC so far has been supportive about the proposal, requesting a considerable amount of information from the NASD as it pursues its petition.

Sen. Robert Bennett's (R-Utah) proposed legislation to require public companies to file Year-2000 compliance information is unlikely to merit a footnote in history.

The Securities and Exchange Commission recently issued Year-2000 disclosure requirements, and the White House weighed in with the appointment of a Year-2000 czar, putting a break on the Utah Republican's political initiative.

Enthusiasm

While Bennett is still planning to continue Senate oversight hearings on his bill, enthusiasm for the proposed legislation has substantially waned.

"I haven't looked at the bill," Sen. Phil Gramm (R-Texas), chairman of the securities subcommittee of the Senate Banking Committee, told reporters at a National Press Club breakfast. He added that he would prefer corporate America to handle the issue on its own.

The Securities Industry Association also dampened the prospects of Bennett's legislation. "We don't think it's necessary," said SIA President Marc Lackritz.

Specifically, Bennett recommended a detailed description of a corporation's progress in Year-200 remediation efforts; a statement of likely litigation costs and liability outlays associated with the defense of possible lawsuits; disclosure of insurance coverage for computer failures and related lawsuits filed by investors; and a breakdown of contingency plans for computer failures.

Interruptions

As previously reported, Bennett expressed his fears about Year-2000 compliance on trading desks in an interview last December. He was particularly concerned about interruptions in market-data streams, noting that a glitch could cause serious harm.

There is no doubt that Bennett helped to focus more attention on Year-2000 compliance even though the SEC and the White House stole much of his political thunder.

For some pundits, Bennett's effort shows just one thing that hours of staff work, burning the midnight oil writing Year-2000 legislation, may, in hindsight, seem fruitless. But for other pundits, the sheer detail in Bennett's legislation, in addition to his Senate hearings, demonstrate a remarkable vision that will not be forgotten easily.

The Securities and Exchange Commission has published for public comment proposed changes to 15c2-11, the rule that governs publication of quotes in securities that are not listed on Nasdaq or an exchange (see Release No. 34-39670).

The rule covers quotations in the pink sheets and on the OTC Bulletin Board as well as the over-the-counter markets in corporate bonds and foreign securities. While the SEC has good intentions, I think the rule would have unintended consequences highly detrimental to investors, issuers and the secondary markets.

The rule would require all market makers to:

* Obtain, review and verify the accuracy of information about an issuer when they initiate quotations in a non-Nasdaq OTC security.

* Obtain, review and verify the accuracy of that information annually if they publish priced quotations.

* Document their compliance and publish the collected information.

The proposed rule requires market makers to have a reasonable basis for trusting that issuer information is accurate and obtained from reliable sources. Market makers would have to ascertain if there are indications of potential or actual fraud or manipulation. The review process applies to both SEC-filing and non-filing issuers.

The proposed rule, however, is based on two flawed premises: that micro-cap fraud will cease if legitimate market makers discontinue publishing quotations in questionable securities, and that market makers should be responsible for issuer information.

It is wrong to give traders responsibility for the accuracy of information produced by third parties they do not control. The potential liability from an implied right of action by investors would drive legitimate firms from making markets, providing the remaining market makers an incentive to refrain from publishing prices.

In fact, it is much easier to manipulate trade reports when firm bids and offers are not transparent. This way, the crooks would have free reign as the honest players exit the business.

A competitive and transparent market should be available for all securities. Regulators should have the tools to punish entities that seeks to manipulate the markets or to defraud investors.

Fraud, of course, takes places across all markets. New York Stock Exchange-listed Centennial Technologies defrauded investors of more than $350 million. The corrupt New York-based penny-stock firm Stratton Oakmont was lead manager in twenty-seven Nasdaq stock offerings, according to Securities Data Publishing.

On Feb. 26, an officer of New York-based A.R. Baron & Co. was convicted of twenty-five charges, including enterprise corruption, scheming to defraud, falsifying business records, perjury and manipulating prices of eight Nasdaq-listed companies.

Alas, forcing issuers to provide financial disclosure does not prevent fraud. Other fraudulent outfits, Comparator Systems and Systems of Excellence, both Nasdaq companies, filed information with the SEC.

The issuers, promoters and retail brokerages that commit micro-cap fraud are violating and ignoring existing securities laws.

But placing higher regulatory and liability burdens on market makers that have no relationship with the issuers, promoters or retail brokers is not the answer to the problem. The market maker's role is to find a price point where supply equals demand. If there are falsehoods in the marketplace distorting the supply and demand, it is the entities that are lying that should be punished, not the honest participants.

As long as securities exist, investors will buy and sell them. If the cost of quoting securities in the pink sheets and the OTC Bulletin Board increases, market makers will pass along the cost to investors in the form of wider spreads and less liquidity for all non-Nasdaq OTC securities.

At the same time, issuers and investors will seek other trading forums with less regulatory overhead, such as issuer web sites or offshore market makers. Consequently, a rule that would encourage a black market does not benefit the public.

While I view the current proposal as the wrong response to a real problem, I hope the final result will be rules and regulations that work. These regulations should:

* Increase investor awareness through education and disclosure.

* Increase the competition, ease of entry, transparency and efficiency while lowering costs to investors for OTC trading.

* Provide issuers with economic incentives to increase disclosure.

* Give enforcement agencies the tools and staffing to keep the markets honest.

The securities industry should view the SEC's proposal as an opportunity to create regulations that will help stop micro-cap fraud. Firms should not just reject the SEC's proposal, but instead offer alternative, viable solutions. I hope the industry finds a reasonable solution that protects investors.

For its part, the National Quotation Bureau has filed a proposal with the SEC to automate the pink sheets and to set up a public repository of non-filing issuer information to enhance market quality.

(The SEC must receive comments on the proposed rule on or before April 27,1998.)

Cromwell Coulson is chairman of the New York-based National Quotation Bureau, owner and operator of the pink sheets.

The National Association of Securities Dealers has proposed an ambitious remodeling of Nasdaq.

The blueprint, however, fails to give credit to the architectural firm that had the most to do with the new design namely, the Securities and Exchange Commission.

Instead of calling the new market Next Nasdaq as originally envisaged, they should have named it Secaq.

The clear message to the dealers is simple: Thanks very much for building such a fine marketplace, but please close the door on your way out.

Admittedly, this exaggerates the effects of the proposed changes, at least the immediate effects. There will still be a need for market makers in Secaq, but that need is clearly diminished. The consolidated or central limit-order book (participation is supposedly optional) is a direct challenge to the heart of the dealer market.

As previously noted in Traders Magazine, the dealers are stinging from a slap across the face.

Some observers, of course, would say that the dealers are getting what they deserve, referring to allegations of price fixing and embarrassing settlements with the SEC and others.

I think, however, that the scandal simply hastened the inevitable takeover by the SEC.

The SEC has taken advantage of the opportunity to force its order handling rules upon the industry, and it is these rules that provide the impetus for Secaq.

It may be that Secaq will be a wonderful marketplace, thanks to the brilliant architects at the SEC. But I have to wonder why they have ceded so much power, and whether investors ultimately would be better served by curtailing that power.

I cannot think of any other market where consumers have benefited from such a concentration of authority in the hands of a government agency.

Nasdaq, with all its faults, is a tremendous success story.

In just a quarter of a century, Nasdaq turned the backwater over-the-counter market into a rival of the New York Stock Exchange. And all that was accomplished while it remained an unabashed dealer market.

As serious as the trading scandal was, it did not frighten away investors.

Even so, Nasdaq has been treated by the SEC as if it were fatally flawed, unable to continue business without a wholesale redesign of its trading system. And, it appears, the NASD has done little more than throw itself upon the mercy of its master.

What can the dealers do? Probably not much. Can they abandon the NASD and form their own self-regulatory organization? Maybe, but they would still have to report to the SEC.

Can they challenge the SEC's authority? They can, but success is unlikely, given their weakened political position. The dealers are now portrayed as the bad guys.

Their every effort to resist the changes being forced upon their marketplace is viewed as a greedy attempt to maintain their unnecessary position as middlemen, skimming off a fat profit that would otherwise stay in the pockets of investors.

A key point lost in the fray is that the SEC, and now even the NASD, is taking away the dealer marketplace. This is made possible by the membership and governance structure of the NASD, as stipulated by the Securities and Exchange Act.

Unlike the exchanges, which are still allowed to limit their memberships, the NASD is required to extend membership to any registered broker dealer.

Because of this open membership, the dealers who made Nasdaq such a success are now faced with the prospect of being squeezed out having lost two things.

First, they have lost the power to control the way Nasdaq is operated, because of the dilution of their power as members.

Second, they have lost the increase in the value of membership.

This means that, not only have they lost control of Nasdaq, but they have also been deprived of any benefit due to the increased value of Nasdaq, for which they are largely responsible.

It is truly ironic, at least to me, that the process of converting Nasdaq to a more order-driven market is the process by which the Nasdaq dealers will lose what exchange members have preserved.

It remains to be seen whether the dealers will leave with a whimper or a bang.

Jeffry Davis is a senior economist with Economists Incorporated in Washington, and formerly was director of economic and policy research at the Securities and Exchange Commission.

Equities trading is about to change, and change dramatically. Ever since Congress passed the Securities Reform Act in 1975, the Securities and Exchange Commission has been attempting to facilitate the establishment of a national market system for trading securities, using modern technology, to accomplish the congressional mandate.

Initially, the commission got it right. The SEC recognized that the best way to obtain the most favorable prices for investors was by leading the industry towards the development of a new system in which all bids and offers for each security could be entered and queued in price-time priority. First-come, first-served, the traditional American measure of fairness would be invoked.

The name of the feature that would make this possible was variously known as a central limit-order book, or CLOB, composite limit-order file, central limit-order file and electronic book.

The ultimate goal was to get investors' orders into this book or file. There was little consideration of integrating market makers' and other intermediaries' bids and offers as well.

However, in an effort spurred by the economic self-interest of the dealers and coordinated by the New York Stock Exchange deathly afraid of a dreaded "black box" approach to trading the market centers talked the commission out of proposing a CLOB. The CLOB was replaced with the disconnected triumvirate of the Intermarket Trading System, the Composite Quotation System and the Consolidated Tape System. When the SEC approved these three systems, it unwittingly ensured that a national market system, as envisaged by Congress, would be almost indefinitely delayed.

But now, nearly a quarter of a century later, following pressure from large institutional investors and others, recognition has finally dawned on at least one market-center operator that the day of the CLOB has finally arrived. Fragmentation of order flow has reached an intolerable level, and it is time to put Humpty Dumpty back together again!

Nasdaq's proposed trading system, containing a limit-order file permitting both investor orders and dealer quotes to be integrated, has caused consternation among many members of the National Association of Securities Dealers.

"Why," they ask, "should the NASD, our regulator, build a system, partly with our money, which will compete directly against the systems we have built or are building with the blessing and encouragement of the SEC?"

That's a tough question with no easy, satisfactory answer for the dealers. So who's to blame? My candidate is the SEC itself. From the day it wimped out and decided to scrap the CLOB, until now, it has focused on encouraging competition about where to trade, rather than at what price the trades should take place. That makes about as much sense as encouraging competing air-traffic controllers at a single airport.

In addition, having a self-regulator it makes little difference if it is the NASD or the NYSE also operate a for-profit trading system creates irreconcilable conflicts of interest. That became evident in the Department of Justice's and the SEC's investigations of the NASD and Nasdaq, and the civil litigation that cost the industry hundreds of millions of dollars.

What should be done? First, Nasdaq should be privatized, and its ownership transferred to the NASD membership that use the system. The NASD should stick to what Congress meant when the Maloney Act created it: self-regulation.

If a privatized Nasdaq can capture the market, let it do so. If other market centers prove superior, let the market not the government decide on winners.

Nasdaq has two important existing advantages, however. First, it is the largest over-the-counter trading system extant today. Second, and perhaps even more importantly, it embraced the concept of a limit-order book, and linked with the most powerful and innovative facility in the last 25 years, OptiMark, a system though unproven, appears to meet the needs of most institutional investors for low-cost and efficient order handling, minimal market impact and anonymity.

In the meantime, there will be a major battle among the dealers who wish a CLOB would disappear and the executives who make policy for Nasdaq. The SEC will be an interested observer, and will have to balance the needs of investors against the interests of intermediaries. It will be a fascinating fight to watch. The winners, hopefully, will be American and international investors.

Junius W. Peake, a former NASD governor, is Monfort distinguished professor of finance at the University of Northern Colorado.

The creation of a file for the consolidatation of investor orders, or a CLOB, was proposed as far back as 1976 by the Securities and Exchange Commission. But Professor Junius W. Peake believes the CLOB was overwhelmed by dealer objections, causing the SEC to "wimp out." The CLOB finally reemerged as an NASD proposal last December. Peake provided the following chronology of SEC plans as outlined in commission releases.

1976

The commission believes that there is a need for further modernization and improvement of our securities markets…Further, existing limit-order mechanisms are unable to provide nationwide limit-order protection, and thus cannot always provide the degree of protection for limit orders which hopefully could be furnished by a composite book.

Finally, a composite book appears to be well-suited to assuring an opportunity for public orders to meet without the participation of a dealer.

(Securities and Exchange Commission, Release No. 34-12159, March 2, 1976)

1978

The commission continues to believe that one of the basic principles upon which a national market system must be based is the assurance that all agency orders in qualified securities, regardless of location, receive the benefits of auction-type trading protections.

To this end, the commission believes the several self-regulatory organizations should take joint action promptly to develop and implement a central limit-order file for public agency orders to buy and sell qualified securities in specified amounts at specified prices…

The objectives of a central file are relatively simple: to make available a mechanism in which public limit orders can be entered and queued for execution in accordance with the auction-trading principles of price and time priority.

(Securities and Exchange Commission, Release No. 34-14416, Jan. 26, 1978)

1979: The End of the CLOB

The commission received several proposals describing alternative means of achieving the goal of nationwide limit-order protection. The National Association of Securities Dealers submitted a "Technical Plan for the Development of a national market system," describing an electronic facility (based upon the technology and hardware of the existing Nasdaq system) functionally similar to the central file proposed by the commission.

The technical plan contemplates that any qualified broker could enter limit orders into the facility for execution by qualified market makers based upon price and time priority within the system. The NASD's board of governors, however, expressly reserved judgment on the policy and regulatory issues associated with implementation of the facility described in the technical plan.

Specifically, the NASD noted that further study was necessary to determine whether exclusion of non-public limit orders from the central file and whether protection of orders entered in the file against executions at the same price as well as executions at an inferior price would be appropriate.

Most other self-regulatory organizations opposed creation of a central file…These commentators argued that the absolute time priority proposed to be afforded public limit orders entered in the central file would have significant deleterious effects on the exchange-trading process.

(Securities and Exchange Commission, Release No. 34-15671, March 22, 1979)