`Stock Market of Future' Hits a Bump on the Way

NASDAQ - the second-largest securities trading market in the United States after the New York Stock Exchange (NYSE) - has come under the glare of public scrutiny.

A federal probe into Nasdaq trading patterns is reportedly reaching into the trading desks of many major brokerage houses throughout the US. The probe threatens to erupt into a highly publicized trading scandal.

Not surprisingly, a ``wall of silence'' regarding Nasdaq operations is going up around the offices of brokerage houses and trading desks on Wall Street.

``When the silence becomes this great, and people become so reluctant to comment, then you just know that everyone of importance is getting into line with their battle gear on,'' one long-time Wall Street analyst says.

Nasdaq, which calls itself the ``stock market of the future,'' has made impressive gains in recent years. It is the electronic trading system of the Washington-based National Association of Securities Dealers Inc. (NASD). Unlike the NYSE, Nasdaq has no trading board - that is, no trading floor where stocks are bought and sold and listed on a giant screen. Nasdaq's operation is a vast computerized system that links brokerage offices and trading desks.

Once known as the ``over the counter market'' for smaller companies with market capitalizations below that required for membership on major exchanges, Nasdaq is now a trading powerhouse rivaling the NYSE. In November 1994, Nasdaq counted 4,905 companies in its trading system, compared with 2,544 firms listed on the NYSE and 837 on the American Stock Exchange.

In terms of trading volume (the number of shares actually traded), Nasdaq is out in front, with a total volume of 68 billion trades through November, compared with 67 billion trades for the NYSE (also called the Big Board), and 4 billion for the American Stock Exchange, according to Brett Surprenant, a Nasdaq spokesman. Many computer firms, such as Microsoft Corporation and Intel Corporation, are traded on the Nasdaq system.

Given its growing number of market trades, Nasdaq has been the envy of many of its rivals. The controversy began last year when two university professors released findings of a study showing that the spread between ``buys'' and ``sells'' was so great that it raised the possibility of ``tacit collusion'' on the part of dealers. After the results of the study were published, a number of investors, who claimed they had been overcharged, filed civil lawsuits.

``What most smaller investors haven't realized is that there are two trading systems involving Nasdaq: an `inside system,' where the broker first buys the stock for a buyer, and the `outside' system, where the broker then sells the stock to the customer,'' one market analyst says. The difference between what the dealer pays for the stock and what he sells it to the customer for is the ``spread.''

Both the Securities and Exchange Commission and the Justice Department are looking into the spreads on Nasdaq transactions. About 30 major brokerage houses in the US are reportedly being required to fill out extensive 41-page documents called civil investigative demands, spelling out Nasdaq trades for a 10-year period going back to Jan. 1, 1985. Apparently, the government also is asking investment firms to list telephone numbers and salaries of Nasdaq traders. It even wants the layouts of trading floors.

Many institutional investors and some smaller investors have raised eyebrows over the fact that the Nasdaq spread narrowed not long after the academic article first appeared. The NASD subsequently appointed a seven-person committee, headed up by Warren Rudman, a former US senator, to look into Nasdaq's trading practices.

The Rudman Commission report is expected to be completed by spring, according to James Spellman, a Nasdaq spokesman. Nasdaq trading volume has not been affected by the recent controversy, he says.

``I expect added regulatory oversight'' to eventually emerge out of the current investigations,'' says William Christie, a professor of finance at Vanderbilt University in Nashville. Professor Christie co-authored the study on spreads with Prof. Paul Schultz of Ohio State University in Columbus.

Christie says he does not expect Nasdaq to ``disappear'' because of the federal probes. On the contrary, Nasdaq has become highly beneficial, he says. This is true for brokerage houses making a market in a Nasdaq stock as well as for the companies that would find it difficult to raise new investment capital without Nasdaq.