Small Investors Are Big Winners In Nasdaq Probe Sec Investigation Should Yield Lower Costs, Level Playing Field

For months, the lobby of the Securities and Exchange Commission has been full of men in dark suits, toting luggage with New York airport tags and whispering into cell phones.

Wall Street, welcome to a Washington inquiry.

As the two-year investigation of the Nasdaq stock market and its parent nears an end, small investors pouring their money into the stock market for retirement already stand to be the big winners.

With one of every three American families invested in the market, one of the biggest investigations in SEC history is expected to result in lower costs, and a more level playing field, for many of the trades these smaller investors make.

The SEC is not expected to fine the National Association of Securities Dealers Inc., Nasdaq’s parent. Instead, in a proposed settlement, the agency intends to publicly rebuke the NASD for failing to enforce key rules, sources familiar with the investigation say.

SEC officials have said they expect the investigation to be wrapped up by August.

But behind the scenes, ever since the SEC and a related Justice Department investigation began in October 1994, the SEC has worked actively to force a major house cleaning.

In the course of settlement talks, “there will be some background meeting of minds” about new rules to increase competition in the trading on Nasdaq, says John C. Coffee Jr. of Columbia University Law School, a top securities expert.

Whatever happens legally, the case marks a turning point for Nasdaq, by some measures the world’s second biggest stock market after the New York Stock Exchange - and the home to superstars of the nation’s new economy such as Microsoft Corp. and Netscape Communications Corp.

The SEC and Justice investigations boil down to two broad questions:

Were big Wall Street dealers deliberately tinkering with stock quotes to boost their profits, thereby forcing investors to pay too much for trades?

Was the NASD an old boys club, reluctant to crack down on powerful Wall Street firms that flouted trading rules, thus allowing them to gain an unfair advantage over smaller traders?

The NASD plays a crucial role in the U.S. stock market: it owns Nasdaq, a highly popular market where $2.4 trillion changed hands last year. And it also serves as Wall Street’s own police force, overlooking 510,000 brokers and 5,400 firms.

NASD investigators work with and refer cases to the SEC, the main federal regulator - an important relationship given the SEC’s small enforcement staff.

The charges against NASD strike at the fairness of the market. NASD is accused of not punishing Nasdaq dealers who don’t honor their quoted prices for stocks, known as “backing away.” It also is accused of failing to punish firms for reporting trades late.

Among changes the NASD already has made: beefing up its police arm by hiring former SEC commissioner Mary Schapiro, giving the police arm new independent powers and appointing a separate board of directors.

Quickly, Schapiro made her mark, saying she would hire 131 new enforcement officials, adding $10 million to her budget and forging closer ties with criminal prosecutors.

The other element of the probe examines whether Nasdaq dealers conspired to keep the “buy” and “sell” prices of stock artificially wide, which increases the trading costs that investors must pay.

Justice’s antitrust division took the lead there, announcing a broad review of the over-the-counter stock market, which includes Nasdaq.

Justice launched settlement negotiations in August with securities firms, according to court records. But industry officials don’t know when those might end, and Justice won’t comment.

Against this backdrop, the SEC last September unveiled a sweeping set of rule proposals to enhance competition on Nasdaq and other markets.

Customers’ orders would be allowed to mingle directly with professionals’ orders. Prices quoted on private computer trading systems, generally a better deal than the public Nasdaq quotes, would be available to everyone.

The NASD has its own set of proposed reforms, a system designed to improve handling of customer orders, but it doesn’t go as far as the SEC.

Regardless of which proposal prevails, says Linda Lerner, attorney for a Nasdaq trading firm All-Tech Investment, “when it’s all over, the over-the-counter market is going to look very different than what it is today.”