NASDAQ's troubles stem from a '90s price-fixing scandal. In response, the SEC encouraged the growth of competing order-driven ECNs, which have since gone on to eat NASDAQ's lunch. To regain competitiveness, NASDAQ now wants to become a full-fledged stock exchange, like the NYSE, which would allow it to raise capital and perhaps buy an ECN.
The SEC is balking. All other U.S. stock exchanges follow "price-time priority" rules that allow customers who offer the best price for a stock to have their orders filled first. It wants NASDAQ to do the same. But at NASDAQ, dealers such as Charles Schwab & Co. and Knight Securities match buyers and sellers on their own books without allowing any other participants to interact. If these market-makers are forced into "price-time priority," they will simply flee to an ECN. NASDAQ is caught between its dealers and the SEC.
The SEC should show some flexibility on its 70-year-old statute on price-time priority. The commission took a step in that direction under former Chairman Arthur Levitt Jr., who ordered all stock exchanges and ECNs to post data about the execution of trades on the Web. This ruling was intended to show investors which market centers were doing the best job. NASDAQ argues that it has the data to prove that investors get high-quality execution, even though it doesn't follow "price-time priority" rules. The key issue before the SEC should be the desire to ensure that investors get the best possible trades regardless of the formal rules governing the trading institution. NASDAQ promoted entrepreneurialism back in the '90s. It deserves another chance to play that key role today.