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In this recent research note, Sandler O'Neill + Partners, L.P. Principal Richard Repetto examines why the public exchange operators hold multiple licenses and that rationale behind this phenomenon.

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December 1, 2003

Is Nasdaq Tilting At Windmills? Embattled Organization Tries to Make History

By Gregory Bresiger

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  • Is Nasdaq Tilting At Windmills? Embattled Organization Tries to Make History
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Nasdaq, once a giant of the trading industry and the dominant player in OTC trading, has stumbled over the last few years.

"They certainly have had their troubles," said Steve Swanson, president of Automated Trading Desk, an electronic brokerage based in Charlotte, North Carolina. Nevertheless, Swanson says he is confident that Nasdaq's new leadership will "figure it out."

Nasdaq is now taking a big gamble that it can convince the regulators to take unprecedented steps. This is a gamble that could result in the biggest stumble of all for this embattled organization.

The litany of stumbles over the past three years is considerable: Unexpected red ink. The biggest part of that was the alarming drop in the revenues of Nasdaq's Transaction Services, which generates critical trade reporting, access services and execution fees business. This group's revenues over a year and a half dropped by about 40 percent to just $60 million in the second quarter. In the third quarter, the problems continued when Transaction Services revenues decreased to $54 million. Nasdaq's foreign ventures have been an embarrassment, with its German, Japanese and European operations all recently shuttered.

Some ECNs have declined to use the so far disappointing SuperMontage trading platform, which Nasdaq officials had once predicted would lead the organization to capture a whopping 70 percent of the OTC market. That has not happened.

But Nasdaq's much heralded trading platform also has stumbled. That's because the platform was launched without a dedicated sales force that could show market participants its usefulness.

The SEC's snail like review of Nasdaq's exchange status application has hurt. The application, filed in November 2000, was designed in part to generate new sources of income and free it from the oversight of the National Association of Securities Dealers.

This delay has been very costly for Nasdaq. It has also led to the forced departure of several Nasdaq leaders. Some execs likely fled voluntarily, dreading Nasdaq's future. Some were involved in efforts to win approval of the application and the failure led the board to install new management.

More Capital

The inability to win exchange status also hampers the efforts of Nasdaq to compete because it is cut off from needed capital. "It hinders Nasdaq's ability to quickly respond to ECN competitors," according to a report by financial consultanting firm Celent Associates, "Nasdaq: Here for the Long Haul?" Nasdaq responses are sluggish because, in the organization's current holding pattern, every critical decision requires the approval of two boards of directors -Nasdaq's and the NASD's. The latter continues to be its nominal parent and retains a 55 percent stake in Nasdaq.

These woes have all added up to an even bigger problem for the struggling Nasdaq: The loss of a considerable amount of market share. For example, back just before the launch of SuperMontage, Nasdaq had some 25 percent of the market, according to Celent Associates. But, by the beginning of this year, the share number had declined to 19 percent. By late summer, the number was down to 16.6 percent.

Predictions of Nasdaq's collapse have been frequent. New leadership was brought in, with Robert Greifeld taking over as Nasdaq's President and CEO.