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June 30, 2002

The Author's Nasdaq Predictions

By Mark Ingebretsen

The order handling rules, a by-product of the Nasdaq price-fixing scandal, encouraged the growth of ECNs. Despite ECNs, a place for human intermediaries is welcome. That's good, but computers can beat grand masters at chess. These are some of the comments by Mark Ingebretsen, author of the new book, "Nasdaq, A History of the Market That Changed the World," in this interview with Traders Magazine's Tom Taulli:

Traders: Let's say, there was no price-fixing scandal during the 1990s, would Nasdaq be different now?

Ingebretsen: ECNs existed prior to the order handling rules. But they were by and large reserved for professional traders. The rules opened them up to the public. The result was a revolution in day trading and the huge upsurge in online volume.

Traders: What's your opinion of the rules overall?

Ingebretsen: Exposing limit orders transformed the Nasdaq's market structure from a quote-driven market, where dealers' quotes set the price, to more of an order-driven market where customer orders set the price. Trading on Nasdaq now more closely resembles trading on the NYSE.

Traders: So have ECNs siphoned order flow away from Nasdaq dealers?

Ingebretsen: Last I checked, ECNs as a group commanded about 40 to 50 percent of overall Nasdaq volume. Remember that volume has risen dramatically across the board since the order handling rules.

Traders: So what kind of future do you see for the Nasdaq dealer market?

Ingebretsen: Many financial firms will hedge their bets, continuing to operate market making divisions, while also taking a growing financial stake in ECNs. I'd like to think that there will always be a place for a flesh-and-blood trader. Then again, computers can now beat grand masters at chess.

Traders: Will the SuperMontage be successful?

Ingebretsen: SuperMontage is really very similar to [the defunct] OptiMark. Yes, I think it will be successful. The key will be whether it becomes the platform of choice in a revamped national market system.

Despite the pending merger between Instinet and Island, I still believe SuperMontage will have the largest pool of liquidity. Nasdaq's member firms will become owners of SuperMontage, thanks to privatization, giving them a vested interest in making SuperMontage work. SuperMontage will not be the only game in town. The two biggest competitors will likely be Island/Instinet and Archipelago. The key for them might well be the amount of liquidity they can provide in listed shares. It might also be how well they're able to integrate with foreign markets. But in the long run, Nasdaq's brand image is its most valuable asset.

Taulli: You talk a great deal about Nasdaq privatization in your book.

Ingebretsen: Obviously, it's an essential move. You can't expect the post office to compete with Federal Express. And that's the predicament Nasdaq's been in as a quasi-association. It needs to streamline decision making in order to compete effectively. Privatization will do that. Ironically, I think privatization will open the door to more public scrutiny if Nasdaq shares trade publicly. Shareholder activist groups will demand a voice, just as they do with any public company. The battles - if they happen - will be more out in the open than before.

Traders: Let's turn to a smaller market: Was Nasdaq's acquisition of Amex a good step?

Ingebretsen: The Amex has always had problems developing a critical mass of listings. The Nasdaq acquisition was an attempt to shore it up, while giving investors a choice between a dealer and a specialist market. However, the merger took place during the tech boom, and Nasdaq's popularity eclipsed the Amex's.

Taulli: Finally, when will the Nasdaq and NYSE bury the hatchet. Will they eventually merge?

Ingebretsen: The Nasdaq and the NYSE are like Coke and Pepsi. Their competition helps everyone. I hope they never merge. I think you're going to see continually shifting alliances with other domestic and foreign trading organizations.