In February 1971, the workaday lives of hundreds of over-the-counter market makers were permanently transformed. That was when the National Association of Securities Dealers started requiring dealers to publish their quotes on a brand-new computer system continuously throughout the day.
The change cast a giant floodlight on the murky world of OTC dealing by driving dealers’ wholesale quotes out into the open. Previously, the only price information the general public had about thousands of OTC companies were the retail quotes published once a day in the newspaper.
The system, of course, was Nasdaq, or the National Association of Securities Dealers Automated Quotations. It was the creation of Gordon Macklin, then the new president of the NASD and a 20-year veteran of the securities industry.
Macklin, a Cleveland native who in 1975 would become Nasdaq’s first president, died in January at the age of 78 at his home in Vero Beach, Fla. He was considered a giant of the industry in his day, respected by both regulators and traders. Macklin was president of Nasdaq from 1975 until 1987, and headed the NASD from 1970 until 1987.
As Nasdaq’s leader for its first 17 years, Macklin expanded the fledgling system from a quotation and trade reporting medium, not unlike today’s rudimentary Alternative Display Facility (ADF), into a full-blown inter-dealer trading system. Volume exploded during this period, soaring from 2 billion shares to 38 billion shares per year.
In 2000, Traders Magazine Executive Editor Peter Chapman conducted one of the last interviews with Macklin for a story on the history of Nasdaq. We publish for the first time an edited version of the interview here.
TM: In 1971, did you foresee the Nasdaq system becoming the all-purpose trading facility it is today?
Macklin: Nasdaq came on line as sort of an automated Pink Sheets, a quote utility. But the expectation was that it would take on new features. There are many different ways to build a system. We chose to build it in a modular fashion, so that you take one step at a time. If they’d put in a full-blown system back in 1971, I don’t think we would have had any subscribers. We really evolved in the way the customers-the owners and the clients-took us. We went from retail quotes to wholesale quotes. We went from wider spreads to narrower spreads.
TM: The first iteration of Nasdaq didn’t require actual wholesale quotes. You struck a compromise between retail and wholesale quotes?
Macklin: In order to build a system that would be accepted by the users at the time, it was planned and built-with the SEC’s concurrence-with certain features that protected the dealers’ profits. It didn’t protect them per se, but it made it easier to profit. Before Nasdaq, what they printed in the newspaper were the retail quotes. So, for example, on a $20 stock they would take a quarter [of a dollar] off the bid and add a quarter to the offering price. That was the public quote. So you’d get 211/4 to 221/2. Frankly, that was the custom.
TM: So it would’ve been a big leap to go to full-blown wholesale quotes.
Macklin: To go from that to stark-raving high-bid, low-ask was an impossible leap. When Nasdaq came online, its way of computing quotes was to take the mean of the bids and a representative markup between the bid and ask-representative of any individual dealer, rather than what the best bid and offer was. Nasdaq was designed to approximate retail quotes with some slight shaving. They had a wide spread that made the OTC business very profitable in limited volume.
TM: What did the issuers want?
Macklin: The issuers wanted narrower spreads. They wanted the highest wholesale bid and the lowest wholesale offering, just like exchange quotes. And then let the broker explain any additional charges he puts on. That was a huge breakthrough.
TM: Your next step was to add trade reporting. I gather there was some resistance to that idea as well.
Macklin: Yes. We ultimately went to trade reporting. And every step of the way, there were those who predicted the demise of liquidity and ruination of the system, and even the declination of the American standard of living! But taking it in an evolutionary fashion, people were able to get used to it and they found, in every case, without fail, that each market improvement generated significantly more volume. So it was, “Yes, my margins are pinched, but I’ll make it back in volume.”
TM: Was this ACT-Nasdaq’s trade reporting system?
Macklin: No, it was part of the formation of the National Market System. The SEC ordered us to bring some of the Nasdaq stocks into the NMS. To put them on the tape.
TM: That was 1982?
Macklin: Exactly.
TM: Trade reporting also meant a big investment on the part of dealers?
Macklin: They didn’t used to report trades. Now they had to report the trade within a minute. They had to put new people on the desk to report the trade at the time of the trade. That caused operational problems galore, because it was brand new-plus the operating expenses. People figured out ways to automate it. And ultimately when they saw the amount of volume it produced … that was helpful.
TM: It also shone another light onto dealers’ trading practices.
Macklin: That’s right. They would say, “If I report my trade, you know my cost. So when I go out to resell it, an institutional buyer can say, Well, you only paid 221/4 for it. Why don’t I just give you 221/4 plus 6 cents?’ ” But that wasn’t as bad as it looked.
TM: It was still a big change.
Macklin: It was a radical change in the way trading rooms functioned. There was a lot of debate. Literally, the cry was that it would destroy the OTC market. One of the guys who was somewhat tentative when we started was Victor Wright at Goldman Sachs. And one day he posted something like 16 million shares of MCI. Just a huge string of trades. He said, “When I started reporting these trades, I became more visible; and the more visible I got, the more trades I got.” Victor Wright played a key role in the automation of the market. Also Bernie Madoff. These were two guys who lived through all that and had big money tied up in facilities and inventory.
TM: SOES came along in 1984. That gave the dealers a whole new set of problems.
Macklin: When SOES came online, that caused real business problems. That was bloody. One of the things that went wrong with SOES and some of the other projects was that there wasn’t enough testing before they came online of what would happen after.
TM: And the SEC didn’t provide any relief?
Macklin: When the SOES bandit thing started … I think the SEC could have been a little kinder toward the market than they were, but they weren’t. But that doesn’t mean that executing orders through the system was a bad thing. The general philosophy behind all these improvements was to make it easier for the customers to execute orders in an automated mode. That is very healthy for markets. And frankly, how could you handle these volumes without these facilities?
TM: The immediate impact of most automation seems to be lower dealer profits.
Macklin: Every time you introduce an efficiency, it means you’re taking some profits out of the trade. However, it’s proven without fail that as you execute transactions in a more efficient way, you broaden the market. The volumes have certainly risen to prove that time and time again.
TM: One of the early overhauls Nasdaq made came in 1980. What was that like?
Macklin: In 1980 we had to re-equip the entire system with new terminals, new concentrators, new lines, new everything. That was like changing a tire as you’re whizzing down the turnpike. To re-equip a very active online system without stopping is hard to do. Traders would harass the installer.
TM: I guess the relationship between Nasdaq and the market makers has never been completely smooth.
Macklin: Trading is high-pressure work. And to disrupt people doing it is very painful. It’s not difficult to understand why they rebel about changes. But on the other hand, there is a bigger issue out there besides the pain of the guy on the desk. Frankly, working toward improved customer facilities and service has served the market and the customer and the industry extraordinarily well.
TM: Thanks, Gordon.
