COMMENTARY: NASD-Y HABITS WILL HAVE TO CHANGE
Barely a peep has come out of the National Association of Securities Dealers since it was censured on Aug. 8 for failing to halt widespread price-fixing of stocks on its NASDAQ market. In a settlement negotiated over two months, the NASD agreed to spend at least $100 million during the next five years to upgrade policing efforts, to develop an audit system for tracing every stock transaction, and to improve surveillance. The unprecedented action against the world's second-largest stock market should correct the unfair advantage brokerage firms have held over investors for years.
Why is the NASD so quiet? It's out of character for an organization that fought the Securities & Exchange Commission at every turn during the 18-month investigation. But the association knew better than to bad-mouth the settlement. Says an SEC official: "We told them, `If you deny the allegations, you do so at your peril."'
Now that the SEC probe has concluded with a pact highly critical of the over-the-counter market, the question remains: Will the NASD voluntarily embark on the road to real reform? If its record is a guide, the answer is no.
CHEERLEADER. The settlement is no act of repentance. Indeed, the two top executives, Joseph R. Hardiman and Richard G. Ketchum, have never acknowledged serious market flaws. This denial persisted in the face of SEC evidence of an NASD "culture" that tolerated trading violations. SEC negotiators were stunned that a week before the pact, Ketchum was disputing the issue at the heart of the probe: the existence of a "pricing convention" in which brokers colluded to keep bid and ask prices artificially wide to line their pockets at investors' expense. Even Wall Street brokerages had confirmed to the SEC an ingrained system for keeping spreads wide.
What's most disturbing is that the NASD was aware of burgeoning problems as far back as 1990 but did nothing. Settlement documents depict an organization that neglected its oversight responsibility and became a cheerleader for its NASDAQ stock market.
When the trading abuses came to light in 1994, the NASD viewed them as a public-relations problem rather than a call for self-examination. One reason: The NASD was dominated by a few dozen firms--among them Merrill Lynch, Smith Barney, and Dean Witter--whose self-interest was the status quo. When NASDAQ continued to boom, the NASD took it as an endorsement from its customers.
At a time when the NASD should have been spending more money to police its 5,400 member firms, its 1994 annual report trumpeted a bigger advertising budget to "broaden NASDAQ's market recognition and trust." Money also was spent on studies to refute criticism. In the settlement, the SEC refers to one unusual arrangement with an economist: If the NASD didn't like the results of a commissioned study on trading costs, it would pay an extra $1,000 to prevent publication.
Public relations permeated every effort, including a 1994 committee headed by former Senator Warren B. Rudman (R-N.H.), to propose organizational changes. The NASD agreed to adopt most of the Rudman group's recommendations to overhaul the NASD's structure. The SEC fumed that the NASD expected cosmetic changes to put an end to the SEC probe. To its credit, the SEC resisted huge lobbying from Wall Street firms.
SKEPTICAL. To the end, the NASD failed to come clean about its problems. In early June, the SEC sent the association a draft settlement. But the NASD continued to oppose the inevitable censure and publication of details of NASDAQ trading violations. The lawyers argued that the SEC would undermine confidence in the market and hurt liquidity of the stocks that trade there.
NASD member firms still are facing a class action. Their lawyers worry that admitting any trading violations could end up as part of the court case. But the silence strategy has backfired, resulting in a steady drumbeat of bad press. Inside the NASD, there are worries that the larger NASDAQ companies will start jumping to the New York Stock Exchange.
Much of the pain could have been avoided had the NASD been more cooperative. The whole matter "should have been resolved a long time ago," says SEC Chairman Arthur Levitt Jr.
The commission is skeptical the NASD will move fast and far enough. The agreement calls for the association to hire an independent consultant to report back to the regulator on compliance. But the commission should be wary that the NASD doesn't hog-tie the consultant, much as it did the Rudman committee. The SEC should keep an eagle eye on the market to make sure the reforms aren't just another public-relations ploy.By Michael Schroeder