Off Topic-General Investment Info
New Rules for Nasdaq Trading
Are Discouraging Some Firms
By DEBORAH LOHSE
Staff Reporter of THE WALL STREET JOURNAL
New trading rules imposed on the Nasdaq Stock
Market are putting an increasing squeeze on some major
dealers in small stocks.
Late last week, industry powerhouse Merrill Lynch &
Co. informed its Nasdaq traders that it is dropping
about 350, or 40%, of the Nasdaq stocks it trades.
Bear Stearns Cos. also has dropped 20% of its Nasdaq
stocks, to 400, in the past two months, according to
people familiar with the matter.
Meanwhile, some smaller brokerage firms say revenues
from "payment for order flow" are drying up, too, as a
result of the new trading rules. Payment for order flow is
a controversial practice under which discount and
on-line brokerage firms that direct trades to certain
trading firms receive rebates, amounting to several cents
a share, from those firms.
The result, traders say, are shrinking profit margins.
These traders contend they are less able to set profitable
"spreads" between the prices at which they will buy and
sell Nasdaq stocks. Nasdaq traders came under fire
from the Securities and Exchange Commission and the
Justice Department in recent years for keeping spreads
too wide.
Sweeping New Rules
The profit-margin squeeze began in January when the
SEC imposed sweeping new rules that for the first time
allow some "limit orders" from investors to help set
prices, if they are better than market makers' quoted
prices. Limit orders specify the price at which the
investor wants to buy or sell, rather than requesting the
prevailing market price.
The rules also force market makers to publicly display
their best prices on Nasdaq's public trading system, not
just on private systems like Instinet.
Meanwhile, Nasdaq and other exchanges now allow
stocks to be quoted in increments of 1/16 of a point --
or 6.25 cents -- rather than the previous minimum for
most stocks of 1/8 of a point, or 12.5 cents. The lower
the trading increments, traders say, the lower their
spreads and profit margins per trade.
Merrill says it is focusing for now on trading only 500
stocks that generate profitable volume, or on stocks of
companies with whom Merrill has other corporate ties.
A Bear Stearns spokeswoman had no immediate comment.
"The market has changed a lot over the past year," says
Tom Joyce, Merrill's co-head of U.S. stock sales and trading.
High-Volume Tech Stocks
Among the stocks Merrill will drop are many regional
financial stocks, which Mr. Joyce expects will be picked
up by regional trading firms. Among the stocks Merrill
will continue trading are high-volume technology stocks,
Mr. Joyce says. "We are focusing our resources on
stocks that are most important to our key institutional,
individual and issuer clients."
Representatives for several other large trading firms,
including Travelers Group's Smith Barney Inc.,
Goldman, Sachs & Co. and PaineWebber Group's
PaineWebber Inc., say they don't have imminent plans
to drop any Nasdaq stocks. But many such firms have
trimmed their Nasdaq rosters within the past two years
in anticipation of the new rules.
As trading firms' profits are pinched, the firms have less
money to pay for order-flow from discount or on-line
brokerage firms. E*Trade Securities, for example, used
to reap about $9.50 per transaction from order-flow
payments, adding up to about $36 million during the past
three years, says Christos M. Cotsakos, president and
chief executive of E*Trade Group, the parent company.
Now, however, such payments have fallen to about
$5.50 per trade for the current year, and Mr. Cotsakos
expects that amount to drop to as little as $1 to $2 per
transaction by the end of next year. Moreover, by 1999
the expects such payments to become negligible.
"Payment for order flow is going away," says Mr.
Cotsakos, who says that new clients and product lines at
E*Trade have more than compensated for the
decreased payments, with revenues growing more than
100% a year.
A spokeswoman at FMR's Fidelity Brokerage Services
said that payment for order flow had "decreased
somewhat" although she declined to give specifics. At
Datek Online, which gets payment for order flow for
only a limited number of stocks, the well is similarly
running dry, according to Pete Stern, a partner at Smith
Wall, the technology company for Datek Online. "Every
month or two [firms that pay for order flow] re-arrange
their pricing and say 'we can no longer support these
types of orders,' " he says. "The envelope for payment
for order flow is definitely drying up."
However, E*Trade has cushioned the blow through a
special profit-sharing arrangement it has with a
consortium of brokers and traders called RoundTable
Partners. Instead of outright payment for order flow, the
discounters recoup some of the trading profits if they
route orders to Knight Securities or Trimark Securities,
depending on how much firms have invested in the
consortium and how much order flow they route to the
firms.
Kathy Levinson, E*Trade's executive vice president of
customer operations, says the arrangement has helped
E*Trade recoup about one-fourth to one-third of the
revenues they've lost from reduced payment for order
flow, although she expects such income to taper off in
the coming years.
Trading firms have long warned that squeezed profits
could ultimately harm small investors, by making it
harder to find a willing trader in some thinly traded
stocks and by raising commissions at discount
brokerage firms.
Richard Lindsey, the director of market regulation at the
SEC, dismisses such alarmist talk, saying the changes
are healthy reaction to increased competition and better
prices on Nasdaq, adding that new participants will pick
up the slack where warranted. "We expect people are
going to realign their business to areas where they think
they can serve the market best," Mr. Lindsey says. |
