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August 31, 2001

Jefferies Sidelined By Dealers' Storm

By Peter Chapman

Jefferies & Co. has decided to wait out the storm in the dealer markets.

The institutional market maker is hoping for bid-ask spreads to recover before resurrecting its ambitious plan to make markets in 3,000 Nasdaq stocks, according to the firm's president John Shaw.

Jefferies, in fact, is freezing its Nasdaq roster at 1,600 names. That's because, it says, decimalization has narrowed spreads so much that trading carries more risk but less reward.

Jefferies' traders are told not to trade much in the current market environment unless it is to fill customers orders. "We're encouraging people to be flat at all times," Shaw said. Previously, a trader might go long 5,000 to 10,000 shares in 10 or 12 names, wait for one or two to take off, then flatten the rest and ride the upswing.

"Now, you can't do that," Shaw said. "You don't get enough movement in the stocks." Spreads have shrunk, but volume and volatility have not increased. Traders must take on larger positions to make the same profits. "It's a much more dangerous game," Shaw said.

Jefferies began its ramp-up in January 2000 when it traded just 600 issues. It wants to be in the top 3,000 Nasdaq stocks to satisfy customers that trade baskets, which mirror such indices as the Russell 2000.

Shaw is cautiously optimistic that spreads will widen in the near term. "With SuperSOES, you might see spreads return a little," he said. "I don't mean in the top 120 names or so, but in the names where agency doesn't really work and you need spreads to get liquidity."

The top Nasdaq stocks are expected to trade on an agency, rather than principal basis. Traders will represent customer orders as brokers rather than fill them as dealers using their capital.

Charles Schwab is reportedly in talks to buy Jefferies for its institutional network. The market making giant would likely disband Jefferies' Nasdaq operation, sources speculate, as it already runs the second largest Nasdaq desk on the Street.

The firm had no comment. However, a source close to Jefferies said management has always said it wants the firm to remain independent.