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March 10, 2009

Before the Fall

By Peter Chapman

At the time, BMIS was a small and struggling wholesaler, finding it difficult to make headway against larger and more established competitors. Eager to compete based on the quality of its quotations, the firm was often ignored by other dealers. Often as not, Madoff's firm did not get called when there was business to do.

The over-the-counter market in the 1960s was dominated by large New York-based wholesalers. These are brokerages that maintain inventories in securities and fill orders for other brokers. The top wholesalers of the day included Troster Singer, Singer & Mackie, New York Hanseatic, J.F. Reilly and Eastern Securities. Wirehouses such as Merrill Lynch did run OTC desks, but their presence was negligible.

So when the NASD was tasked with developing a quote display system that could be installed in dealing rooms around the country, Madoff saw the potential. "We felt, as a small market-making firm, it would level the playing field for us," Madoff told author Eric Weiner for his book "What Goes Up: The Uncensored History of Modern Wall Street." "So we pushed that concept, and I was not particularly popular with my competitors."

With all quotes displayed in one place throughout the day, market makers would have to do business with those displaying the best prices, no matter who they were. That would give a newcomer like Madoff a fighting chance. It would also cut into the business of the dominant players.

The NASD set up an automation committee in 1964, the year after the SEC report came out. It was chaired by Robert "Stretch" Gardiner, head of Reynolds Securities, and staffed with executives such as Johnny McCue, from Baird & Co., a regional broker, and Joe Fuller, from J.B. Maguire, a Boston wholesaler. Madoff was not on the committee.

Seven years later, after much kicking and screaming by traders, the National Association of Securities Dealers Automated Quotation system, or Nasdaq, finally launched. Credit is given to the now-deceased Gordon Macklin, Nasdaq's first president, for making it happen.

In the end, Nasdaq did what they thought it would. It brought quotes to the surface and competition to the market. Small wholesalers such as BMIS and J.B. Maguire and regional brokers such as Baird got a seat at the table. Spreads narrowed. Large wholesalers including Singer & Mackie saw their margins squeezed.

"Nasdaq gave those relative unknowns a sort of instant prominence," Singer & Mackie executive vice president Robert Mackie Jr. told Financial World magazine in 1973. "If they make the best market on that machine, people are bound to do business with them. Before Nasdaq, there was no way for the small firm, except through a strenuous effort, to get itself known as a market maker."

For Bernie, it was never a just one-way street. He got from the NASD, but he also gave back. The former head of trading from a large New York firm remembers Bernie "always made himself available in the early days of Nasdaq when it was hard to get volunteers. He was always willing to be involved in a committee or to help out somehow. After a while, he became a leading voice and was influential and valuable to Nasdaq."