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Which market offers lower transaction costs -- Nasdaq or the New York Stock Exchange? The difference might be just pennies per share, but that seemingly small margin, multiplied over many shares, can be substantial. Paying only 1/16 of a dollar more per share -- 6.25 cents -- makes for a $62.50 difference on a 1,000-share order. Across all trading, the difference adds up to billions of dollars.
Now the Securities & Exchange Commission is about to enter this fray. It's expected to soon release the most comprehensive study yet comparing trading costs for the two markets. The SEC declined to comment on the results in advance. But according to one source familiar with the work, the report is expected to indicate that for Nasdaq's most actively traded stocks -- the Intels, Oracles, and Ciscos of its world -- transaction costs are about the same as the NYSE's. However, for lesser-traded stocks, Nasdaq's costs begin to rise and are significantly higher on the lower rungs than its rival's.
FAT MIDDLEMAN? The study focuses on spreads -- essentially the brokerage's cut of trading activity. In Nasdaq's computer-based system, dealers, known as market-makers, stand in the middle, buying stock from those selling and selling shares to those buying. The spread is the difference between those prices. For instance, a dealer might buy shares at $17 and sell them at $17.13, the 13 cents being the spread. With its trading-floor system, the NYSE operates differently, but the same basic idea holds.
Academics have done similar studies to the new SEC one, and the methodology is all basically the same. Still, the new report will be noteworthy in two respects: For starters, it has been done with much more reliable data than were available before. In the past, it has been difficult to match actual stock trades with the prices being offered at the time of the transactions. Now, greater analytical precision is possible because Nasdaq is collecting better data in the wake of its price-fixing scandal in the mid-90s.
And that leads to the second noteworthy point: The study will reflect the fruits of recent years' Nasdaq reforms, such as smaller pricing increments -- now in sixteenths and heading for pennies -- and new rules enacted following the scandal. Should the study show the NYSE still enjoys an advantage, it's expected that the difference will be smaller than previous analysis has indicated. While the NYSE will be able to say "Told you so," Nasdaq will be able to counter: "Yes, but we've shown the most improvement."
Who's right? In a sense, both. Risk -- measured by things like volume and volatility -- is a major driver of spreads. The riskier the stock, the bigger the spread that the pros expect for handling it. Dealing with Nadaq's younger high-tech companies usually entails more risk and thus produces higher spreads than the NYSE, with its established, higher quality companies.
FAIRER TREATMENT. Beyond the academic exercise, the study could be the basis for SEC regulations designed to open markets and give investors the opportunity for a better deal. That's been a tireless theme of SEC Chairman Arthur Levitt Jr., who has long sought to level the playing field between big institutions and retail investors.
Levitt hopes that competition between the two markets will lead to lower transaction fees for both. There could yet be veiled practices or biases that favor insiders and institutions at the expense of the public. Indeed, unsavory practices periodically come to light. Questions still swirl around the appropriateness of the premiums some dealers charge in many Nasdaq stocks and whether the kind of competition among dealers for orders that Nasdaq likes to tout really exists.
According to the SEC, at least 85% of Nasdaq orders are routed based on agreements made between market players -- deals that some believe elevate transaction costs. For instance, a brokerage might agree to steer its customers' orders to a particular market-maker in return for being paid a couple of pennies per share. The market-maker simply agrees to match the best price prevailing in the market.
Critics complain that this system is ripe for legalized kickbacks. Others contend that it's competition itself because the brokerages can use the market-makers' payments to rebate commissions they charge to individual investors. They say that's where some of the low per-trade commissions you see advertised come from.
TRACING FOOTSTEPS. Regardless, this practice of payment for order flow undermines price competition, at least to some degree, because it means transactions keep going to a dealer no matter what its quotes are. And that's where the SEC study could leave a mark -- to the extent that continuing differences in investor costs between Nasdaq and the NYSE can be traced to such payments.
With its strong consumer focus, Levitt's SEC has already saved investors billions of dollars, say his many fans. The chairman recently tagged the SEC's reform efforts as working "toward markets driven by footsteps" -- that is, traceable transactions. His agency's upcoming study won't necessarily settle longstanding questions about the Nasdaq-NYSE competition. But it should shed light on who's leaving the footprints and could result in even lower trading costs.
By Christopher Schmidt in Washington Edited by Douglas Harbrecht
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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