Nasdaq Settlement Raises Fears

The settlement of an investigation of Nasdaq will accelerate a housecleaning in the electronic stock market, probably making it a fairer place for investors.

But the changes that grow out of the settlement with the Securities and Exchange Commission - and other pending reforms - could have a severe unintended consequence: making stocks harder to find.

Critics warned Friday that dealers will see tighter profits trading stocks in smaller companies and shun the kinds of securities that helped make Nasdaq the world’s second-largest stock market.

“What’s going to affect public is if I’m not there to put my capital up for second- and third-tier stocks. Then the public will be up a creek without a paddle. That’s the real concern,” said E.E. “Buzzy” Geduld, president of Herzog, Heine, Geduld Inc. a major Nasdaq dealer.

Those concerns emerged a day after the SEC brought its milestone case against the Nasdaq Stock Market and its parent, the National Association of Securities Dealers Inc. The case was the second major enforcement action this summer against Nasdaq.

The NASD agreed to settle the SEC’s 18-month case by accepting a censure, agreeing to expand its enforcement budget by $100 million, and undertaking more than a dozen specific reforms aimed at strengthening the market’s regulation.

Rules pending before the Securities and Exchange Commission also will radically change handling of customer orders on Nasdaq, which the SEC argues is the next leap to improve the market and lower trading costs for investors.

The SEC’s report highly criticized the conduct of Nasdaq dealers, particularly for colluding to keep buy and sell prices artificially wide, which increased trading costs for investors.

The SEC case followed a Justice Department investigation of price fixing involving two dozen Nasdaq dealers last month. A settlement led to increased monitoring of brokers.

The agency wants to go further with a set of rules that would have customer orders directly mingle with the prices quoted on Nasdaq computer terminals. That could sharply reduce investors’ trading costs.

Wall Street firms warn they may be less willing to risk their money dealing in smaller, more volatile stocks. Such a trend, if it developed, would mean small companies would have a much tougher time raising money in the markets.

SEC Chairman Arthur Levitt Jr. dismissed concerns that small stocks might be abandoned due to the Nasdaq reforms.

“If they do, the history of our markets has been such that there will be plenty to come behind and they’re willing to take it up,” Levitt said.