The two distributors of automated stock quotes to over-the-counter traders are racing to be the first to debut an electronic trading system.
The development comes as surging volume on Nasdaq's OTC Bulletin Board, and on the New York-based Pink Sheets, had traders reeling earlier this year. Automated trading, they say, could help them process more trades faster. Dealers in the non-Nasdaq OTC market currently get their quotes from screens but trade by telephone.
Last month, the board of the National Association of Securities Dealers approved a proposal for an automated order delivery system for the Bulletin Board. NASD says the proposed system – which requires Securities and Exchange Commission approval – is a necessary response to a surge in the trading of Bulletin Board stocks in recent years.
The regulator says average daily share volume has exploded from 41 million shares in 1995 to 323 million shares in 1999. Patrick Campbell, the chief operating officer at Nasdaq, credits the surge to increased retail trading and efforts by the NASD and Nasdaq to protect investors from the fraud that is legion in the market.
"They're going to have to automate it [Bulletin Board]," said Frank Held, trading chief at the Jersey City-based micro-cap wholesaler Wm. V. Frankel. "Trying to get through to many of the market makers [in the first quarter] was a joke." Many overwhelmed dealers reportedly did not answer their phones in the tumultuous first quarter.
Pink Sheets LLC, the vendor of quotes of companies unable to meet the stricter requirements of the Bulletin Board, is responding to traders' cries as well. It plans to debut an instant message order routing facility in the first quarter of 2001. Under its plan, market makers of both Bulletin Board and Pink Sheets stocks – the two most active sectors of the 50,000-strong, non-
Nasdaq OTC market – will be able to e-mail their orders and bypass the telephone.
"We intend to take the phone process electronic," said Cromwell Coulson, chairman of Pink Sheets. "Right now we're in discussions with regulators as to how that might work."
Coulson's system is essentially a stripped-down version of Nasdaq's SelectNet order delivery mechanism. It incorporates SelectNet's "directed," but not its "broadcast," features. Dealers buying or selling stock will be able to contact a specific market maker, but not sweep the quotes of multiple dealers.
Some traders question how much use they would get out of it. They say the quality of the quotes on the Pink Sheets – which started electronic dissemination 12 months ago – is often dubious. Surveillance is lax so they don't trust the freshness nor the size quoted. They still make the requisite three phone calls to confirm the quotes. They say the technology is superfluous if they must phone anyway.
"It's extremely loose on the pinks," said a bulletin board trader. "Market makers are supposed to update their markets on a timely basis, but the regulators aren't watching. You don't really have a real-time requirement. It's there, but it's not there."
Nonetheless, dealers still see Pink Sheets' Electronic Quotation System (EQS) as a step in the right direction. "It's a good system," said Nicholas Ponzio, chief executive at Hill Thomson Magid in Jersey City, one of the largest OTC dealers. "It makes for a more efficient marketplace than having to make so many telephone calls. It's been pretty reliable." Ponzio adds that his business has grown with firms that previously shunned Pink Sheet stocks because of the EQS. Transparency has given them confidence in the market.
Ponzio is betting Pink Sheets will be first to market with a trading system. "They seem like they're leaps and bounds ahead of everyone out there," he said.
Whether or not Pink Sheets beats Nasdaq to the punch there are changes afoot that could stimulate demand for its trading system. A separate NASD proposal is expected to lead to a winnowing of stocks from the Bulletin Board. And those that fall off will likely land on the Pink Sheets.
Mary Schapiro, the president of NASD Regulation, told conventioneers at the annual Security Traders Association bash in Boca Raton last month that the NASD planned to convert the Bulletin Board into a "listed" market. Currently companies do not pay NASD to be listed on the Bulletin Board the way they do on Nasdaq. If the Bulletin Board became a listing market, some companies would most likely not meet its requirements. They would drop off and be quoted on the lower echelon Pink Sheets.
Traders are not surprised. "There will always be segregation [between Nasdaq and bulletin board stocks] but Nasdaq will continue to beef up listing criteria for bulletin board stocks," said Sal Dacunto, head of trading at M.H. Meyerson, a Jersey City-based wholesaler in the microcap sector. He also believes the rules applied for trading Nasdaq stocks will be extended to the Bulletin Board. These include Manning, price improvement, and order handling regulations.
Coulson agrees. "I think Nasdaq will put in higher standards and cut the amount of stocks on the Bulletin Board," he said. "That's where they've got to go. Then they'll stick it onto the same platform as the Nasdaq NMS and SmallCap stocks."
Coulson believes the fast and loose Bulletin Board tarnishes Nasdaq's reputation. Nasdaq, in fact, has pushed 3,000 stocks off the Bulletin Board since it started requiring companies in 1999 to file financial statements with regulators.
Many didn't file and landed on the Pink Sheets, which is viewed by some as the OTC trading venue of last resort – one rung below the Bulletin Board. Both markets are considered highly speculative and susceptible to manipulation.
Neither Nasdaq nor Pink Sheets will be the first vendor to automate microcap trading, however. New York's SBX, Inc. operates the SBX Nanocap System, an Internet-based order matching service for trading Bulletin Board stocks. It was designed by Nick Niehoff who also created the all-electronic Cincinnati Stock Exchange.
GlobeNet Capital of Winter Park, Fla., last month introduced a Web-based matching system of its own, having received NASD approval for the ATS. Some dealers have given both systems a cold shoulder, however, saying they disintermediate their services.
