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April 1, 2001

Who's the Fairest of Them All? An SEC report comparing execution quality on Nasdaq and the Big Board

By Gregory Bresiger

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  • Who's the Fairest of Them All? An SEC report comparing execution quality on Nasdaq and the Big Board

Traders are highly critical of the latest effort of regulators to find a best execution standard. Some are contemptuous, suspecting that it is part of a plan to saddle the trading community with more onerous regulations.

A recent controversial study by the Securities and Exchange Commission compared execution standards between the New York Stock Exchange and Nasdaq, finding the Big Board was superior.

"We had a lot of trouble with the report. I don't think the comparisons were valid," according to Harold Bradley, former manager of equity trading for American Century. Bradley complained that three quarters of the Big Board stocks used in the study would not qualify for Nasdaq.

The methods and data of the SEC report, which found the New York Stock Exchange provides better execution standards because its spreads are generally lower than Nasdaq, are under attack in the trading community. While many trading officials concede that regulators should find the best trading techniques to ensure individual investors receive a fair deal, they said the report is a failure because the methodology was flawed and ignored a critical fact: The NYSE has centralized liquidity while Nasdaq has de-centralized liquidity.

Apples to Apples

"The SEC took a one size fits all approach that didn't make sense," said Aldo Parcesepe, head of trading at Bear Stearns & Co. "Company comparisons were not always apples to apples," said Richard Ketchum, president of Nasdaq.

He added that, "Nasdaq companies tend to be younger, less diversified, from quite different industries, and more growth oriented than NYSE companies."

Trading officials also contend that the report was wrong because the SEC still isn't clear on a best execution standard that could cover both institutional and individual investors as well as all the different trading environments in which transactions are recorded. If the regulators, for example, are going to focus on price by measuring spreads, then, in effect, they are ignoring other factors, which might be important to at least some of their clients, traders charged.

"If you focus too much on price, for example, you're forgetting about the volume needs of institutions," said Richard Holway, a former buyside trader who is a founder of Harborside, an electronic block trading tool he oversees for Jefferies & Company.

"I see no value in the study," complained Steve Wunsch, president of the Arizona Stock Exchange. "The SEC was doing nothing but comparing apples with oranges," he said. And Wunsch concludes the regulators are going to use the study as an excuse to suggest more rules for traders, something SEC officials deny.

The effect of the SEC examining spreads - and saying what are and what are not appropriate - could "reduce liquidity," added James Marks, an analyst with Credit Suisse First Boston.

"Squeezing spreads enough might persuade people to get out of the business," Marks warned. Citing the invisible hand concept promoted by 18th century economist Adam Smith, which he said leads business people to offer the best possible prices, Marks said that competitive forces could also be responsible for reducing spreads, but only if firms are encouraged to compete. But traders complain that the regulators don't understand their business.