Nasd Censured For Lax Oversight Crackdown Ordered To Correct Blatant Violations At Nasdaq Market

The world’s second-largest stock market, Nasdaq, has been dominated by a small group of brokers who fixed prices with impunity while those who were charged with regulating the market ignored the illegal behavior, the Securities and Exchange Commission charged Thursday as it announced tough measures to change the way that market is administered.

The commission imposed a formal censure on the National Association of Securities Dealers, the self-regulatory organization that oversees the Nasdaq market. It was the first time the commission had ever censured a major stock market.

The Nasdaq market, which bills itself as “the stock market for the next 100 years,” has grown rapidly in recent years, with a roster of companies that includes leading technology companies like Intel and Microsoft. One commission official estimated that investors in Nasdaq stocks had been overcharged by tens of millions of dollars in recent years.

SEC Chairman Arthur Levitt Jr. said the commission had found a pattern of conduct in which brokers coordinated what they charged customers. “Investors paid too much, and received too little, when they bought and sold stock on Nasdaq,” he said.

Levitt said the anticompetitive practices, far from being a secret, were routinely taught to new traders, and became a part of expected behavior. “Where was the NASD, the cop on the Nasdaq beat?” Levitt asked, rhetorically. “The NASD was not blind to these practices in the marketplace,” he said. “It simply looked the other way.”

When some dealers nonetheless tried to compete on the basis of price, the SEC said, they were discouraged through harassment and intimidation by other dealers. The commission said NASD officials knew of such actions, but did nothing to stop them.

In the last 25 years, the Nasdaq market has grown from a tiny backwater of over-the-counter stocks into a market whose trading volume, measured in dollars, is second in the world only to the New York Stock Exchange.

It is supervised by the NASD, an organization that includes virtually all brokerage firms in the country and that is charged with regulating the market. Unlike stock exchanges, which have trading floors, Nasdaq is essentially a computer system that links brokers, who generally make trades by telephone.

The NASD accepted the censure without admitting or denying the charges, and issued a statement emphasizing the reforms it had already made under the prodding of a commission chaired by Warren Rudman, the former Republican senator from New Hampshire.

Among other things, they separated the regulatory responsibilities from the running of the stock market, and put Mary Schapiro, a former member of the SEC, in charge of the regulatory activities. Levitt said he had confidence in the people now running the NASD.

While the SEC said officials of the NASD knew of the illegal practices, it did not name any of them and apparently has decided to bring no charges against individual officials. But the inquiry remains open, and brokerage firms may yet be charged.

The SEC’s settlement with the NASD calls for that organization to spend $100 million over the next five years to step up monitoring of the market to prevent similar abuses in the past. The money will come from Nasdaq’s budget, which is raised from trading fees and other assessments on brokerage firms. Of that, $25 million is to be spent this year, representing just a 7 percent budget increase for the regulatory operation.

The settlement also calls for a number of changes, some of them already implemented, to prevent such things from happening again.

The settlement, many of whose terms had been leaked earlier in the week, was announced Thursday afternoon, less than 24 hours after the end of negotiations that had gone past midnight for three consecutive nights and involved the heads of major brokerage firms as well as executives of the NASD.

It appears clear that the practices outlined by the SEC cost investors large sums of money by forcing them to pay more for securities when they bought them, and to get less when they sold them, than might otherwise have been the case. To some extent, those losses may have been offset by reduced commissions, but the net effect was to raise profits of the brokerage industry substantially.

Those profits are likely to come under some pressure as a result of the settlement Thursday, but they could be hurt even more if the SEC goes ahead with its plans to impose new trading rules later this year. Those rules, as proposed last year, were aimed at assuring that investors got the best possible price in trading.

Many Nasdaq traders are outraged by the proposed rules, warning that they would devastate brokerage profits and reduce liquidity in the Nasdaq market by driving brokers out of business, and efforts have been made to get Congress to block the rules.

But the picture of dealers contained in the report released by the SEC Thursday, as well as in a similar document released last month by the Justice Department when it settled antitrust charges against the major dealers, may make it difficult for the dealers to arouse sympathy.

The Nasdaq stock market is a “dealer” market, in which competing brokers known as market-makers stand ready to buy and sell stock.

Each Nasdaq market-maker quotes a “bid” price, at which he stands ready to buy, and an “asked” price, at which he is willing to sell, with the difference called the spread.

Historically, the public could trade only at those two prices. If the price of a stock was $20 bid and $20.25 asked, and an individual wanted to buy at $20.125, the order might not even be accepted, and would not be executed unless the asked price fell to that level.