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April 30, 2004

Nasdaq Struggles With a Problem Child: Little Profits and Little Ability to Regulate?

By Gregory Bresiger

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  • Nasdaq Struggles With a Problem Child: Little Profits and Little Ability to Regulate?

Nasdaq is stuck with the Bulletin Board lease.

Nasdaq's Over-the-Counter Bulletin Board (OTCBB) - launched in 1990 after Congress hoped that Nasdaq and its parent, the NASD, could clean up the penny stock mess - is caught between a regulatory and market dilemma.

The OTCBB, which was designed to provide greater transparency and reassure investors that penny stocks were a legitimate form of trading, makes little or no money. That's even though the OTCBB, which is not a listing market, is in the midst of a small stock bonanza.

"This is a very important market. It is an incubator market for micro stocks. It is an important part of capital formation in the United States," said Nick Ponzio, chief executive of Hill, Thompson, Magid, a prominent OTC market maker.

One big Street player, Citigroup Global Markets, took the plunge when it embarked on plans to ratchet up the number of Bulletin Board names it trades.

Still, at the same time that Nasdaq is stuck with the OTCBB, today it has little ability to discipline sleazy companies. It presides over a marketplace that is an illustration of Gresham's Law (bad money drives out good money).

The problems for Nasdaq are regulatory and the nature of penny stocks. "A small minority of those stocks are questionable and many of the others are risky," according to another executive of an OTC firm.

But Nasdaq, which has an application pending with the Securities and Exchange Commission to become an exchange, would have some problems walking away from the OTCBB. How could it persuade regulators and dealers to accept it as an exchange when it ignores a very important part of the market?

A Nasdaq official dismissed this point, saying the exchange application had little to do with pulling out of the BBX plan last year. "It was merely an attempt to have a listing product that could be part of an exchange," he said. "Today, we operate it as part of the NASD, a registered securities association." Nevertheless, the official conceded that what happens to the OTCBB depends on the exchange application.

All parties agree that the OTCBB is serving a critical market. "Most of the companies in America are small companies. It is very important that the Bulletin Board is run well so companies will have access to capital," said Stephane Touizer, chief executive and founder of Microcap Feed, a market data and technology platform that covers the OTCBB.

But the dilemma for Nasdaq, in running the Bulletin Board, is the unique nature of its membership and the companies in the Bulletin Board. "You can't regulate the 3,500 stocks on the Bulletin Board the same way you regulate Microsoft and Intel," Ponzio said.

A Competitor

Many trading executives say that Nasdaq's structure puts it at a disadvantage. It is a quasi-government entity. However, it is competing with private firms for OTC business. Nasdaq must win the regulators approval to make basic changes by going through a rules amendment process. Nasdaq's private competitors - like FedEx competing against the U.S. Post Office - can be more flexible in changing business plans.