The Nasdaq Stock Market says a surprising decline in brokers making markets in some high-profile stocks is due to aggressive computerized trading by a small group of firms.
The trend, if it accelerates, could damage the fabric of the Nasdaq market by reducing its ability to quickly and smoothly execute trades, warned Richard G. Ketchum, executive vice president of the National Association of Securities Dealers Inc., which runs Nasdaq.At issue is the trading activity of so-called SOES bandits, brokers specializing in small, lightening-quick computerized trades on Nasdaq's Small Order Execution System.
Nasdaq contends these traders abuse a system set up to benefit individual investors. Ketchum, in a letter to the Securities and Exchange Commission, emphasized Nasdaq remains strong but that "our concern is heightened by the speed of the current trend."
Firms that actively trade on SOES, however, called Nasdaq's latest study "a joke" and said it's a part of a harassment campaign by leaders of the nation's second-largest stock market. The SOES firms say they're operating legally.
Here's the dispute and why it matters to investors:
Market makers form the backbone of Nasdaq. These Wall Street firms sign up to buy and sell a certain company's stock with their own money and will also process customer orders.
Nasdaq-listed stocks can have multiple marketmakers - Intel has more than 40 - which stand ready to trade shares. That creates considerable liquidity in the market, or the ability for trades to occur smoothly with minimal changes in price.
A decline in the number of marketmakers can lead to a decline in liquidity, Nasdaq says. That could result in unpredictable swings in share prices from trade to trade, as well as limiting investors' ability to execute trades.
"We're concerned, that in this case, it could be drying up liquidity and that would be bad news for investors," said Nasdaq spokesman Marc Beauchamp.
Nasdaq said it sees a link between heavy SOES trading in stocks and a decline in market- makers. That's because SOES traders issue buy or sell orders against firms that haven't immediately updated their quotes with the trend in the overall market.
The marketmakers, under Nasdaq rules, are required to process the SOES trades, even when they're stuck with a loss.
Ketchum said stocks that lost the most marketmakers "are subject to almost double the percent SOES volume as compared to other Nasdaq National Market stocks."
Harvey I. Houtkin, a leading SOES trader, charged the research was part of a continuing campaign to drive SOES traders out of business.
Alan Davidson, president of Zeus Securities Inc. of Jerico, N.Y., and an advocate of small Nasdaq firms, said if Nasdaq was really concerned about liquidity, it would open the doors to small firms that want to expand their market-making business.
The decline in market makers, Houtkin said, could be caused by other factors, such as firms betting the wrong way on technology stocks this year and exiting leaving the stock. Such turnover is common.
Dean Furbush, the NASD's economist, said he didn't seek another explanation for the decline because he was struck with the strong correlation between heavy SOES trading and the drop in market makers.
From Dec. 31, 1994 through July 20, 50 stocks Furbush studied lost an average of eight market makers, and another group of 50 stocks suffered a nearly 50 percent decline. Although Intel lost 12 market makers during the period, it still had plenty left, about 44 firms.