Nasdaq Agrees to Adopt Auction System To Trade Its Shares and NYSE Issues
The Wall Street Journal - 12/10/1999
The Nasdaq Stock Market took a competitive swipe at the New York Stock Exchange, announcing an agreement to adopt an electronic auction-market system to trade both its and its rival's issues.
Meanwhile, the National Association of Securities Dealers, Nasdaq's parent, approved a preliminary plan for a major restructuring that eventually will separate Nasdaq from the NASD.
The NASD announced an agreement in principle to adopt the trading system being developed by Primex Trading NA LLC.
When an order is entered in Primex, participants compete for it by trying to better the best bid or offer then prevailing in the country. This "auction" process is the heart of the Big Board, but there, only floor brokers and specialists compete in the auction. Primex promises to allow any participant in the country to compete.
Primex "will provide one additional valuable . . . . means to produce price improvement between bid and offer," said Rick Ketchum, president of the NASD.
Primex is the brainchild of Bernard and Peter Madoff, the brothers who run Bernard L. Madoff Investment Securities, a so-called third-market firm whose primary business is competing with the NYSE and regional exchanges for orders in Big Board stocks.
But its other backers include the exchange's four largest member firms Merrill Lynch&Co., Morgan Stanley Dean Witter&Co., Goldman Sachs Group Inc. and Citigroup Inc.'s Salomon Smith Barney unit.
Bernard Madoff said in an interview that he had talked to both Nasdaq and NYSE officials about adopting Primex. "We chose Nasdaq because it . . . . would include all the Nasdaq and New York securities, and we also felt the technology fits in better with Nasdaq," he said.
An NYSE spokesman declined to comment.
Nasdaq, which gets exclusive rights to Primex for five years but no equity, intends to implement the system when the markets convert from fractional to decimal pricing. Although that is scheduled for July, Mr. Madoff noted that the industry is pressing for a later date, because it is uncertain that its technology can handle the expected surge in quote and price traffic.
Here is how Primex would work. Suppose the highest bid on a stock is $101 on the Big Board and the lowest offer is $101.10 on the Chicago Stock Exchange. An investor sends an order to sell stock at the highest price its broker can find, a so-called market order. A dealer or investor in Primex could send an offer to buy the investor's stock at $101.05, better than the Big Board's bid. Dealers could automate their participation, so as to automatically bid, say, two cents better for every order.
But the system has its drawbacks. First, once an investor's order enters Primex, it can't be executed on the New York Stock Exchange or any other market, where it might get an even better price, or, just as important, find a counterparty willing to trade a larger number of shares. Indeed, the opportunity cost of not trading in the NYSE's heavily trafficked market is the main reason many clever, competing trading systems have failed to eat into its volume.
On the other hand, Primex's backers account for a significant chunk of the NYSE's volume which, if shifted to Primex, could give Nasdaq a formidable inroad.
Second, there is some question how much "price improvement" will be possible once markets switch to decimals. If, as expected, many stocks trade with a one or two-cent spread between the bid and offer, any price improvement would be relatively modest compared with the current increment of 6.25 cents, a sixteenth of a dollar.
"Price improvement is price improvement, whether it's two cents or six cents," Mr. Madoff said.
The NASD's board also inched forward with plans to separate Nasdaq from its parent, though no details were confirmed. Much of the two-step private placement currently under consideration already has proved contentious. Among the thorny points How much of the deal will go to smaller vs. larger NASD firms and whether big Wall Street firms will get too much control over the market; whether members will be allowed to vote on the first step in the plan, which would sell a minority stake in Nasdaq; the valuation of Nasdaq, tentatively set at around $1 billion; and whether NASD should get all of the proceeds of the deal.