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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

The SEC, traders said, is looking at a market from an individual investor viewpoint, which was its primary concern when it began operations in the 1930s and individuals then made up 90 percent of the market. But today, with the popularity of retail mutual funds, the market has radically changed and the idea of what is an individual and what is an institution is skewed, they say.

Mutual Funds

Several traders asked: Should a big mutual fund designed for retail investors be classified as an individual or an institution?

"The study means nothing. It compares numbers of transactions, but not the supply and demand and the unique environment of each market," Wunsch said.

The controversial document, "Report on the Comparison of Order Executions Across Equity Market Structures," held that the Big Board is better because "the listed market structure is significantly less fragmented" than Nasdaq. That means significant savings for the investor. On trades, for example of 100 to 499 shares, the spread was some five cents to eleven cents more per share on most Nasdaq trades compared to the Big Board, according to the study. Nasdaq spreads were also higher for 500 shares to 4,999 share trades.

Why were these spreads better? SEC officials privately said their study proved that centralized order flow was more efficient. However, in trying to assuage some of their critics, they emphasized that this was only one study. And they said that more studies are needed before any conclusions can be reached about the best market structure.

Tranquil Period

The SEC study was done during a one-week period from June 5 to June 9, 2000, which the SEC said was "a relatively tranquil period that followed a period of higher stress and volatility."

So the regulators concluded, after this week of study, that exchanges like NYSE are superior to Nasdaq because, "the primary exchanges are predominantly agency markets in which investors' orders interact directly. In contrast, no single market center accounts for a majority of Nasdaq trading, and most of the trading is done with dealers with relatively little interaction between customer orders," wrote the SEC's Office of Economic Analysis in the report.

Unsurprisingly, NYSE officials praised the report, while Nasdaq officials disputed it. Nasdaq President Richard Ketchum, for example, said Nasdaq had made progress with various "enhancements" over the last few years in reducing spreads, especially among very large stocks. "These enhancements have brought spreads down by over 75 percent since 1966," Ketchum said.

However, the NYSE, in a statement, said the SEC study, "validates our own empirical evidence that NYSE issuers and their shareholders benefit from the concentration and direct interaction of orders our market provides."

Centralization, say NYSE officials, has been upheld by the study. "Our agency-auction model joins the greatest liquidity and transparency with the most efficient method of price discovery, leading to the lowest execution costs and best prices for customers," according to the NYSE.