With smaller profit margins hurting the payment-for-order-flow business, some industry experts are waiting for the first big merger among major Nasdaq wholesalers. Already, rumors are swirling on Wall Street that Nasdaq powerhouse Mayer & Schweitzer and Jersey-City based competitor Herzog, Heine, Geduld may merge.

According to sources close to Herzog's trading desk, Mayer is negotiating a purchase of Herzog. The sources said that the acquisition was not imminent, but expected a deal to be completed by year's end.

E.E. "Buzzy" Geduld, president of Herzog, said there was no truth to the rumor. A Mayer spokesman had not returned calls at press time.

A combined Mayer and Herzog would be a formidable giant. Mayer and Herzog were ranked first and second, respectively, in the AutEx year-end rankings of Nasdaq and over-the-counter volume for 1997. Mayer, a New York-based Charles Schwab Corporation affiliate, had an advertised trading volume of 12.4 million shares, according to the AutEx 1997 rankings. Herzog had a 1997 advertised volume of 11.08 million shares.

Minneapolis-based Dean Rauscher, a full-service regional brokerage and investment bank, is acquiring Twin City rival Wessels, Arnold & Henderson in a deal valued at $150 million. The nominal purchase, which is expected to close March 31, includes $120 million in cash and $30 million in five-year subordinated debentures. The price tag is more than 13 times Wessel's estimated 1998 earnings.

Rob Gales, head of equity trading at Wessels, cited a strong combination in research expertise as reason for the agreement. "Dain has a proven background in financial-services and energy research," Gales said. "Wessels has a strong research staff in technology, healthcare and consumer-product [sectors]."

He added that Wessels agreed to the merger to have access to Dain's network of 1,200 retail brokers. "I also think with our office in Palo Alto, Dain can make a push to expand in California," Gales said.

William A. Johnstone, Dain's vice chairman, and Wessel's Chief Executive Kenneth J. Wessels will lead the transition team.

On Tuesday, Feb. 10, the media-relations people at the New York Stock Exchange issued a press release that said Cleveland-based American Greetings will "wrap the New York Stock Exchange building with a giant, red ribbon to hail its transfer from Nasdaq."

Sure enough, on Feb. 11, the card and gift company wrapped the red flag around the hulking exchange and distributed 4,000 announcement cards, 1,500 pocket calendars and 500 boxes of chocolates throughout the morning at the corner of Broad Street and Wall Street. The press release was headlined, "American Greetings Wraps the NYSE as a Gift Celebration of Transfer from Nasdaq." Ouch.

A little triumphalist perhaps? "We wanted to make an interesting headline," responded a spokeswoman for the exchange. "The media does that kind of thing all the time." American Greetings is the fifth company to transfer to the Big Board from Nasdaq this year, coming on the heels of record transfers in 1997.

The National Association of Securities Dealers may have a tough time convincing traders that its proposed integrated order-delivery and execution platform suits them. But one of the NASD's top officials, Rick Ketchum, is trying very hard.

"We're going to look at a means to pass on the execution-fee income of the book to the market makers themselves," said Ketchum, referring to the voluntary limit-order book and order-delivery system that would replace SOES and SelectNet. "We think the book should be designed in a way that's a benefit to the market makers."

Nasdaq Blueprint

In an interview at the NASD's Washington headquarters, and in follow-up telephone conversations, Ketchum laid out Nasdaq's blueprint for the proposed trading platform, originally dubbed Next Nasdaq, and boldly dismissed suggestions that the NASD is seeking competition with market makers. Aside from the commissions market makers could charge for executions via the limit-order book, Ketchum repeated that there could be profit-sharing arrangements in store.

"We don't want to design this in a way that it is competing against our members," said Ketchum, chief operating officer at the NASD. "[As the facilities processor] we want to pass through the execution-fee income to market makers who are stepping up and providing liquidity in the market." Ketchum did not elaborate, except to say the NASD is "tossing around" several ideas.

The proposed Nasdaq system's greatness, Ketchum continued, is that "investors can control their orders, and at the same time, market makers can have a central and unique place that encourages liquidity in the market. We'll never do anything to jeopardize that. We don't think the book does."

OptiMark

The original interview took on dramatic new life as soon as the NASD announced an agreement in principle between Nasdaq and OptiMark Technologies. The plan aims to integrate OptiMark with Nasdaq's trading platform and planned limit-order book.

Ketchum acknowledged, however, that plans for the limit-order book and the OptiMark plan are not foregone conclusions. "[OptiMark] is not a done deal," he said. "It is an agreement in principle."

Nevertheless, Kethum believed that a large group of NASD members supported the limit-order book, another large group opposed the book, and a third was sitting on the sidelines.

"Our main effort is going to be to get out there and answer their questions," Ketchum said. "We're continuing to look at a variety of questions with respect to our book, and we'll use the notice and comment period as a means to try to respond to legitimate concerns."

A prominent critic of the NASD's plan, Bernard L. Madoff, who chairs the Securities Industry Association's Trading Committee, contends that the current NASD proposal would create a system that competes with market makers.

Under an alternative plan proposed by the SIA Trading Committee, limit orders would come into Nasdaq and then be rerouted to market makers on a rotating basis. Nasdaq's limit-order book would serve as a fail-safe system, and display any limit orders market makers were unwilling to display. Market makers would receive a fee for putting the limit orders in their quotes.

Ketchum said the NASD is continuing talks with the SIA's Trading Committee, and will present the SIA's trading-platform proposal to Nasdaq's Quality of Markets Committee. That may just be a pro-forma move. "It is our judgment that the limit-order book provides the level of benefits to investors that justifies our moving forward," Ketchum said.

Conciliatory

Ketchum struck a conciliatory tone, singling Madoff for praise. Madoff has been "the most effective competitor to the New York Stock Exchange…in the history of listed trading," he said.

"Madoff and his firm are perfect examples of how market makers can provide value-added over a limit-order book, and why they will continue to flourish in this environment," Ketchum added.

The NASD does not envision significant costs for firms if the proposed Nasdaq trading platform is approved by the Securities and Exchange Commission. Current workstations would be used. The limit-order book would be called up as a separate page like any other electronic communications network when it appears on the screen.

"[Market makers] would be able to call it on a separate page, but they'll have to call it to get the whole book," Ketchum said. "That's a key difference in the limit-order book. It would disseminate all the limit orders, not just the top of the book. The order-routing and execution system again should be seamless, and dramatically reduce their exposure and difficulty in handling orders."

The NASD is hoping for final SEC approval by June, and to implement the proposed trading system, perhaps with OptiMark on board, by year's end.

The Securities and Exchange Commission is putting pressure on mutual funds and investment advisers, as well as public companies, to state clearly how they are tackling the Year 2000 computer problem.

At issue are mounting concerns that computers, not adequately programmed, will interpret the standard two-digit year code 00 as Jan. 1, 1900, instead of Jan. 1, 2000, a flaw that could ultimately hurt investors.

The agency did not mince words in a Jan. 12 staff bulletin, stating its case for Year 2000 disclosure. With that bold move, it may now be pointless for Sen. Robert Bennett (R-Utah) to press ahead with legislation he introduced earlier, requiring extensive disclosure of companies' Year 2000 compliance plans

Nevertheless, Bennett, who nicknamed his legislation Crash, quickly seized upon the SEC's bulletin and praised "[SEC] Chairman Arthur Levitt for his leadership and courage in taking this initiative. The information I will receive from reviewing the results of this new bulletin will be very valuable in determining how to proceed with my own legislation."

The SEC bulletin states that for any company that "has not made an assessment of its Year 2000 issues, or has not determined whether it has material Year 2000 issues, the staff believes that disclosure of this known uncertainty is required.

"The determination as to whether a company's Year 2000 issues should be disclosed should be based on whether the Year 2000 issues are material to a company's business, operations or financial condition, without regard to related countervailing circumstances (such as Year 2000 remediation programs or contingency plans)."

The Year 2000 problem is likely to preoccupy Washington as the new millennium draws near. For investors, the impact of massive Year 2000 computer glitches are almost too frightening to contemplate.

"Just suppose a company runs up against a sudden outlay, perhaps a big balloon expenditure in 2000," explained a government official familiar with the problem. "Instead of earning 4 cents per share, for example, the investor could wind up with a 6 cents per share loss. Investors are relying on companies to know what they are doing."

Bennett, chairman of the Senate Financial Services and Technology Subcommittee, held a series of hearings on the subject last year, and in November introduced the Computer Remediation and Shareholder Protection Act.

"The Year 2000 problem lies at the heart of our economy," said Bennett. Investors, he added, deserve to know companies are responding to the Year 2000 challenge.

Bennett's bill would mandate the SEC to amend its disclosure regulations and require companies to disclose a wealth of information about Year 2000 compliance. Specifically, they would have to provide a detailed description of their progress in Year 2000 remediation; 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 failure.

This is the second time in recent months that an influential Republican senator has attempted, in effect, to legislate a top-level agency's rule-making authority. Sen. Lauch Faircloth (R-N.C.) blunted the Federal Accounting Standard Board's proposed rules on derivatives, prompting a top SEC official to privately complain that Faircloth should have stayed clear of that controversy.

The SEC official believes Bennett's Year 2000 legislation was out of step with reality. "You usually don't have new rules for every topical problem. The revised bulletin simply tries to make clearer what is already on the books," the official said.

Meanwhile, the Security Industry Association's board of directors supports a proposal to declare Friday, Dec. 31, 1999, a trading holiday in order to complete as much year-end processing as possible before 2000 begins.

A ten-member panel, created last year by a U.S. Department of Labor advisory body to review the soft-dollar business, has received mixed reviews.

The panel, set up under the auspices of the 1997 ERISA Advisory Council on Employee Welfare and Pension Benefit Plans, recommended that Labor and the Securities and Exchange Commission make some statutory and regulatory changes.

ERISA, or the Employee Retirement Income Security Act, enacted in 1974, sets minimum standards for private-sector pension plans.

Fees

Specifically, Labor was urged to require plan sponsors to report all fees above $5,000 paid for with directed brokerage. Plan sponsors would also be required to certify that they are complying with the existing requirements of ERISA Technical Release 86-1 in directed-brokerage programs.

Labor was asked to recommend to the SEC that the Section 28(e) definition of research be changed, and that it prepare a list of which brokerage and research services are acceptable purchases with soft dollars. Investment managers would be required to provide clients with full disclosure of all trades for each client involving soft dollars, and the benefits investment managers receive from those rebates. They would also be required to detail their policies involving soft dollars.

In addition, disclosure of external research provided to investment managers would be required.

Howard Schwartz, chairman and chief executive of New York-based Lynch, Jones & Ryan, an institutional brokerage firm, said he was "very pleased that the soft-dollar and commission-recapture business which [Labor] has said fosters brokerage-industry competition and ultimately benefits individual pension-plan investors is moving toward self regulation."

The report is "very much in line" with the Securities Industry Association's new best-practices guidelines for soft dollars and other commission arrangements, added Schwartz, who is chairman of the SIA's Soft-Dollar Committee. Schwartz testified before the Labor panel, representing the SIA.

But another industry official, requesting anonymity, was not impressed with the soft-dollar report. "It is unworkable and not well thought out. I don't believe the SEC engages in substantive-type regulation. How do you determine whether Bloomberg is an acceptable research product and fails the test?," asked the official. "People were expecting the production of a credible report, but it is too vague, too general."

Main Concern

The panel's main concern was whether plan fiduciaries have sufficient guidance to properly administer their pension plans in compliance with ERISA's fiduciary requirements. The panel was given a mandate to study the need for regulatory changes or additional disclosure to pension-plan sponsors and fiduciaries on soft-dollar and directed-brokerage practices.

One soft-dollar expert thinks the panel's recommendation could have a far-reaching impact. "If they [the recommendations] are carried out, they will have some significant impact on business," said Lee Pickard, a Washington-based attorney and counsel to The Alliance in Support of Independent Research. A paper written by Pickard, "The Provisions of Investment Services by Broker-Dealers: A Guide to Soft-Dollar Practices," was submitted to the panel for review.

The Association for Investment Management and Research (AIMR), a Charlottesville, Va.-based non-profit trade group, has released a proposed set of soft-dollar standards for its buy-side members.

The standards, developed by a blue-ribbon task force of industry leaders convened by the trade group, are open to public comment until Feb. 28.

Understanding

These standards include the creation of a common understanding of soft-dollar issues by providing definitions of major terms; and requirements that the content of research purchased with client brokerage directly assist an investment manager in his decision-making processing, and not in the management of the firm.

Also included in the standards are a clarification of an investment manager's responsibility to justify the use of client knowledge to pay for a portion of mixed-use products.

Disclose

The standards require AIMR members to disclose certain information with regard to soft dollar practices; uniform record keeping; and clarification of an investment manager's real and fiduciary responsibilities to his client, including the client-directed brokerage area.

These responsibilities cover the client-directed brokerage area.

Under prodding by market makers, the National Association of Securities Dealers is proposing to push back its phase-in of a system designed to electronically capture more than two dozen trade details.

The first component of the Order Audit Trail System (OATS), the direct entry and capture of trade information, was originally to be implemented this August. Non-electronic procedures were to be covered starting Jan. 1, 1999, followed by all other orders on Jan. 31, 2000.

Under an amended proposal filed with the Securities and Exchange Commission, the NASD wants to push back the first phase to February 1999, the second phase to August 1999 and the final phase to July 31, 2000.

The original schedule was criticized by market makers because they said it strained their technology resources.

In addition, adopting the OATS requirements, mandated by the SEC, was making life difficult for traders coping with other major changes, such as the order handling rules.

SIA

As previously reported, the Securities Industry Association's OATS Ad Hoc Committee complained that more time was required to comply with the workload involving OATS.

"A technological undertaking of this kind requires more time [to program and to test]," stated the committee chairman, Bernard L. Madoff, in a letter to the SEC.

The SIA committee had warned that the original schedule put an unfair burden on small and medium-sized Nasdaq trading desks that were unlikely to have the order flow to run in-house audit-trail systems.

Their only option was to use service bureaus and their clearing firms, the committee stressed. Indeed, the real winners would be clearing firms that offer "one-stop shopping [for their correspondents]," the SIA committee maintained.

The SEC is expected to approve the NASD's revised OATS plan, according to industry sources.

NASD Regulation has come down firmly on member firms on Year 2000 compliance. The regulatory subsidiary of the National Association of Securities Dealers has demanded that members report on their progress in making their computer systems compliant.

Mary Shapiro, president of NASD Regulation, said in a prepared statement that it is essential that broker dealers' computer systems continue to operate successfully after Dec. 31, 1999.

"It is imperative that firms aggressively take on the Year 2000 challenge, and that the automated systems they rely on to meet their regulatory, market-participant and investor-protection obligations be Year 2000-compliant," she said.

NASD Regulation's request was announced in a so-called NASD Special Notice to Members. The notice stated that it is the responsibility of members to analyze the readiness of their own automated systems.