Some of Pershing's management and business products will remain in place – and may even prosper – under its new Bank of New York owner.

Pershing's CEO Richard Brueckner and COO Brian Shea, will still continue to manage the same business, according to Joseph Velli, head of BNY Securities Group.

On the systems side, Pershing's front and backend platforms will be introduced to Bank of New York correspondents.

For Pershing loyalists, that's a good start to its marriage to Bank of New York. Some observers had expected that each entity would continue to peddle its own front-end systems. These systems are used by registered reps who work at correspondent firms.

Last month, Bank of New York finalized its acquisition of Pershing. The combined entity creates the world's largest correspondent clearing firm, called BNY Clearing.

Bank of New York, however, plans to pull the plug on BNY Clearing's backoffice unit in Milwaukee. Some of these employees have found positions at Pershing headquarters and at its service center in Oakbrook, Ill.

Hard-pressed state lawmakers have come up with another taxing trading idea.

But the so-called transfer tax on stock sales in New York State, many hope, will never become a reality. That's unlike Section 31(a) fees and brutal trading taxes which are imposed by federal lawmakers.

A transfer tax was one of the measures proposed recently by some New York State lawmakers who are seeking to close a $12 billion deficit.

The measure is opposed by New York City Mayor Michael Bloomberg. The Securities Industry Association is also opposed. The SIA, reflecting concerns raised by New York trading houses and exchanges, notes that investors would likely shift trades to market centers outside New York State to avoid the tax.

The introduction of a transfer tax still remains a possibility for New York, especially if the deficit problem worsens. If the tax became law, it could encourage investors to use ECNs and regional exchanges, the SIA argues. That could hurt trading jobs in New York.

Still, there is support for the tax from the New York-based Fiscal Policy Institute. This group has demanded a $0.05 tax on each share traded with a cap of $35 per trade. The Fiscal Policy Institute believes investors would not defect in large numbers to regionals and ECNs.

Wall Street opponents are obviously aware that, if the tax is enacted, it could take a long time to repeal. Despite some relief measures, Section 31(a) fees, paid by Nasdaq dealers and NYSE trading firms, still generate huge sums from stock transactions.

The battle over Nasdaq's future – whether the regulators should finally give approval to its exchange application – is not over.

At least that's what one of its major competitors is telling lawmakers. NYSE officials recently sent a blistering letter to a member of Congress about Nasdaq's seemingly interminable exchange application, which is now some two years old.

There is no indication the application process will end anytime soon. "The commission is considering the matter," an SEC spokesman said. There is also no indication that the heated debate is close to finished.

"Nasdaq's proposed exchange rules violate the existing law," Big Board's counsel recently wrote. These rules would "overturn fundamental, long-standing safeguards that protect investors," he added.

Big Board officials also charge that Nasdaq's history of regulatory problems will mean that – giving it the legal privileges of an exchange – the individual investor will be hurt. They also suggest that there will be scandals as there were in the 1990s. Nasdaq sent its own letter to Congress charging that NYSE's contentions are without any basis. The NYSE is fearful of competition, Nasdaq officials assert.

The charge and counter charge has re-opened a bevy of issues. These divisive issues include Nasdaq's business model, whether for profit-exchanges violate the substance of the 1930s securities laws and if approving the application will allow other markets to make the same metamorphosis by simply citing the Nasdaq approval.

"Nasdaq," said veteran Bear Stearns trading executive Aldo Parcesepe, a critic of the application, "should be a utility and nothing else. I don't understand how it can be a central collection point and then step forward now and be a competitor. It doesn't make sense," he added.

Parcesepe's complaints echo those of some other traders who believe that Nasdaq, as a former regulator and onetime child of the National Association of Securities Dealers, will have unique advantages as a for-profit exchange. The issue continues to divide the trading profession.

"I have no problems with Nasdaq reorganizing itself as an exchange if they feel that it will allow them to provide a more competitive platform," said Mark Madoff, a trading director for market maker Bernard L. Madoff Investment Securities.

Madoff argues that Nasdaq, as a for-profit exchange, will bring more competition to the marketplace. "And even the suggestion of more competition between markets is a good thing," he added.

Fragmentation

The Big Board letter to Congressman Doug Ose (R-Calif), a rehash of previous letters to the SEC, nevertheless raises some other contentious matters on the minds of traders. NYSE Big Board Counsel Richard Bernard wrote that Nasdaq's exchange application, as presently constituted, will further fragment the market and will hurt the individual investor. He argues that Nasdaq's market structure was conducive to conflicts of interest and the dot.com bubble of the 1990s.

"As the stock prices rose and then collapsed in the after-market, Nasdaq dealers went along for the ride, stepping between public orders to pocket the spreads. Derelict directors, ethically-challenged executives and accountants without accountability then destroyed real companies with financial gimmickry, shedding what was left of investor trust and confidence," according to Bernard.

Nasdaq's structure remains a problem, he added. Nasdaq's dealers, Bernard contended, are under no obligation to yield to public orders on Nasdaq's limit order book.

"As one astute observer reportedly quipped, Nasdaq is not an exchange – it's a shopping mall. As a result, by interposing itself between a willing buyer and a willing seller and trading with each in turn, a Nasdaq dealer pockets the bid-asked spread," according to Bernard. He estimates that this process costs investors "$2.0 billion each year." Bernard and his Big Board colleagues state the exchange application, as presently constituted, violates "the provisions of the Securities Exchange Act of 1934."

But Nasdaq officials privately say they see the NYSE's intervention – at this late date – as a sign that they simply fear competition. That's because their structure and execution quality is better than the NYSE, which is losing ground to competitors, they added. Nasdaq's chief counsel, Edward Knight, in his own letter to Representative Ose, wrote that public orders on the Nasdaq are resolved in favor of the investor.

"In fact, Nasdaq market makers are prohibited from trading ahead of their customer limit orders, regardless of whether the limit order is placed in Nasdaq's book or routed to another market maker or electronic communications network," according to Nasdaq's Knight.

"This longstanding Nasdaq rule is called the Manning Rule and is a customer protection requirement developed by Nasdaq and the SEC to address specifically a geographically disparate electronic market."

Ose, a member of the House Financial Services Committee, sent a letter to the Securities and Exchange Commission asking that it move faster. "I remain concerned that the Nasdaq application has been pending at the SEC for well over two years and I urge you to move forward to resolve any remaining issues so that the application can finally be approved."

But SEC Commissioner Roel Campos, speaking at a recent Security Traders Association conference, said he doesn't expect the commission to act on the application in the short term. Obviously, this is because the SEC already has a full agenda of other pressing issues, which includes the divisive topic of ECN access fees.

"I expect that the access fees subject will be handled separately," Madoff predicted. The SEC is also not expected to finish with the Nasdaq exchange application in the short term because there are still several outstanding issues about the exchange application. These are questions about whether more conditions will be added to the application.

Explanation

One of Ose's colleagues, Congressman Richard Baker (R-Louisiana), the chairman of the House Subcommittee on Capital Markets, told Traders Magazine that he is going "to ask the SEC why the application is taking so long. I'd like to have a good explanation for this."

Nevertheless, Ose, in urging that the regulators speed up the process, mentioned several questions that he wants answered about the application. "Won't the SEC's authority over Nasdaq," Ose asked, "be more direct once it becomes an exchange? Doesn't this broad authority empower the SEC to modify the Nasdaq's market structure if necessary?" Ose also wants to know if Nasdaq shouldn't be allowed "to develop a business model that is different from and, in fact, in competition with the NYSE model?" And, he asked, "Is strict price-time priority essential in a decentralized, electronic environment?"

The latter is a sensitive point that was raised in the war of letters to Ose. "The NYSE's position," Nasdaq's Knight wrote, "is that the only type of market that can be an exchange is one that replicates its own auction market structure." That position, Knight added, "is self-serving."

Maybe. But the SEC, which will not comment on the pending application, may have the most difficult task of all the parties to the application controversy: It not only has to decide whether the application is finally approved or not. If it decides to approve the exchange application, it might face a more daunting task: How many conditions might be added contingent to approval?

Some Nasdaq critics, in a paraphrase of backwoods wisdom, might say that "there is more than one way to skin a cat." They are hoping that the SEC would add so many conditions that Nasdaq would give up and just continue operating as it is now. These same critics are also hoping, to quote one, "that additional conditions would be the end of Nasdaq."

Nasdaq officials, in prodding the SEC to act, noted in the Ose letter that they virtually have exchange status already. "As a threshold matter, there is no doubt that Nasdaq is, for all practical purposes, an exchange today. Registration is simply legal recognition of current reality," Knight wrote.

Possibly, but some trading industry executives are sick of the issue, especially the bitter debates between the Big Board and Nasdaq. "Maybe it would be better if both of them [NYSE and Nasdaq] just shut up and concentrated on doing the best job possible," said Bear Stearns' Parcesepe.

by Jon D. Markman

(John Wiley & Sons, New York, 320 pages) $29.95

reviewed by Gregory Bresiger

Hold your positions through thick and thin. And one will make money over the long term. This will happen, in part, because your steady as she goes style will keep your costs low.

Such has been the conventional wisdom of modern portfolio theory. It was a religion many professional traders adhered to up until about three years ago.

That's when a protracted bear market led many professionals to question the wisdom of the temple, especially some of its high priests who said that the Dalai Lama of our economy, Alan Greenspan, had abolished the business cycle. The buy and hold strategy was a can't lose position, said many investment heavyweights. Most of these fellows are probably related to the guys who said the Oakland Raiders were "a can't miss" to win the Superbowl.

But men and women of doubt have appeared over the past few years. They have asked some discomforting questions. What if we are in the middle of a long-term bear market? What if this market bears striking similarities to 1933 instead of 1983? What if the buy and hold idea is the reincarnation of the Irving Fisher analysis of the early 1930s. Fisher was the economist who said that stocks had achieved a permanent plateau, a plateau from which they would never slip.

In the case a 1930s market, one is playing a losing game because there are years of red ink ahead. Many investors and traders, the author of this book would argue, will drop out and take their losses long before the market recovers. So what is an investor or a trader to do?

The author holds that the professional should consider another style, which is neither the guerilla warfare of day trading nor the Buddha/Joe Torre like stoicism of the investor who holds on forever. (The Yankees can be ahead or behind by 20 runs and he always looks the same. Gee, what is the guy drinking on the Yankee bench?)

Sure, if this 1933 investor had 20 or 30 years, he would do fine. But not everyone has either the time or the stomach to glide through disasters, the author warns. This is true. So many investors perform worst than their investments. How is this possible? Because investors – and I suspect more than a few traders – have a tendency to jump ship at the first sign of trouble and, of course, pour too much money into their investments as the market is headed up, but about to peak.

This book explains a third way of trading. It's not day trading. It's not trading for a portfolio that one will hold forever or until pols keep campaign promises. In between these two extremes is swing trading. Swing traders aren't holding their positions like Warren Buffett. And they're not trying to exploit momentary opportunities, writes Jon Markman, who is senior investment manager and portfolio manager at Pinnacle Investment Advisors.

Those following the latter discipline aren't buying and selling stocks over the space of a few minutes or a few decades. Swing traders buy and sell equities over weeks and months, the author explains.

"Conventional wisdom says that long-term holders are the likeliest to succeed, since they lose the least to such money drains as commissions, bid-ask spreads, and taxes. But conventional wise men have had the owl feathers kicked out of them in recent years, as quick-changing technology, an uncertain economy, and manic consumer tastes have made it harder than ever to figure out which companies have so lasting an edge over competitors that their shares merit long-term holds," writes Markman.

One key of this unconventional style is not to fall in love with a holding. Buffett will probably hold Gillette, Coca Cola and Disney until the day he dies. Markman cites swing traders who say they only wanted limited information about the stocks that they own. These traders are cold and unemotional. To them, their holdings are just stock symbols, not companies they've married.

"After identifying a company for purchase or sale through a combination of fundamental and price/volume analysis," Markman writes, "a good swing trader tries to determine the direction of its very next move and to avoid hanging around during inevitable reversals. Swing traders try to take profits quickly after a significant pause in upward momentum, and reinvest them in new opportunities."

Nickels and Dimes

Markman seems interested in distinguishing this style of trading from day trading than from the long-term buy and hold trader. "They [day traders] get crazy for nickels and dimes, while week-focused swing traders play strictly for the $100 bills."

Fair enough. I'd never mistake Markman and his cohorts – many of whom are profiled in this book – for the short-attention span day traders of this world. However, although Markman does a good job of explaining how swing trading works, and making a case for why it may be appropriate for some, the book has one weakness.

Reading this book I started asking myself what is the difference between swing trading and market timing? This is an issue that Markman didn't seem to address. To me, swing trading is a form of market timing. Is Markman telling us that swing trading is an elaborate form of market timing that can work? By the end of the book I wasn't sure. I'm also not sure that buy and hold isn't the best strategy for the average trader and his conservative client.

Still, if Markman's intent is merely to explain how swing trading works and not to proclaim it as the one true religion for all investors and traders, then I think this book works as a textbook for those who have had enough of modern portfolio theory. They've been looking for a religion for the past three years now. This may be it.

The OTC is turning pink. That's because the Pink Sheets may soon become the dominant trading venue in the over the counter market for stocks that do not trade on Nasdaq. And it's all because Nasdaq is planning to dramatically reduce its support for these OTC securities.

Under Nasdaq's plan, the OTCBB will disappear. That will leave the Pink Sheets in control of most of the 7,000 OTC securities bought and sold "over the counter."

Right now, the over-the-counter market is split between two trading venues – Nasdaq's OTCBB and the Pink Sheets. But next January, Nasdaq will launch a new market called BBX, which stands for Bulletin Board Market. The BBX will list the strongest companies on the OTCBB. Six months later Nasdaq plans to terminate the OTCBB.

The proposal is still pending approval by the Securities and Exchange Commission. But if it gets the green light, no more than 700 of the 3,200 OTCBB securities are expected to qualify for a listing on the BBX. The rest will shift to the Pink Sheets, a venue, which like the OTCBB, has many risky securities.

Some 7,000 securities are traded in the over-the-counter market. OTCBB quotes 3,200 of them. Pink Sheets quotes 3,900 exclusively. Pink Sheets could pick up another 2,500 to 3,000 if Nasdaq's proposal is approved. The BBX listing fees and stringent corporate governance standards will likely prevent the vast majority of OTCBB companies from making the cut.

Sleepy Company

The upheaval reflects both the disdain Nasdaq has for its often scandal-plagued sister market and the dramatic transformation of Pink Sheets – from a sleepy publishing company into a modern day electronic trading facility.

The Pink Sheets makes most of its money selling market data and charging market makers "position" fees for each security traded. It is eager to get its hands on 3,000 more securities.

"We would love to have them," said Cromwell Coulson, chief executive of Pink Sheets. "Our goal is to provide a competitive, transparent and efficient medium for market makers to make markets and brokers to transact in these securities."

If Nasdaq's BBX proposal is approved and thousands of OTCBB securities fail to make the cut, the event will mark Pink Sheets' second major windfall in four years.

Between 1999 and 2000, OTCBB de-listed about 3,000 of its then 6,500-name roster. The companies were unable or unwilling to meet new requirements to file reports with the SEC.

At that time, the mass de-listing caused the number of securities quoted on the Pink Sheets' then-new Electronic Quotation Service (EQS) to surge from about 1,000 to 4,000.

Had the EQS not existed, it is questionable whether the SEC would have allowed Nasdaq to de-list 3,000 companies. Prior to 1999, the Pink Sheets was just a pink-colored printout of securities prices and market maker telephone numbers that was distributed to dealers. This relative lack of transparency in over-the-counter prices is what led the SEC to pressure Nasdaq to establish an electronic quotation service. The OTCBB was launched in 1990.

The EQS is popular with traders and Pink Sheets quote data is carried by Nasdaq's Level 1 feed and the major market data vendors. Pink Sheets prices have achieved widespread visibility.

So, transparency is no longer an issue, but the picture today is still more complex than it was four years ago. A listed market with higher corporate governance standards is a much bigger leap for companies than merely requiring them to file with the SEC, observers note. The SEC might be reluctant to approve another mass de-listing.

The BBX is far from a done deal. Nasdaq and the SEC have been going back and forth on the BBX issue for nearly two years. Nasdaq originally filed for its rule change in October 2001. The SEC has yet to publish the proposal in the Federal Register. Publication in the Register would signal the SEC is reasonably satisfied with the proposal and ready to listen to public comments.

Some Grumbling

Although there appears to be little organized resistance to the creation of BBX, there is some grumbling. Market makers object to certain aspects of the BBX. Others say the Pink Sheets is an inadequate venue for the cast-offs.

Nick Ponzio, chief executive of Hill Thompson Magid, one of the largest OTC dealers, is strongly opposed to BBX as currently envisaged. "I am disappointed Nasdaq has not created something the market makers can participate in," he said. "I've been trading Nasdaq my entire career, so I am disappointed their product is something that may not work."

Specifically, Ponzio's complaint is about spreads. He says the BBX would eliminate the ability of a market maker to commit capital because of the rules that govern spreads. Because many OTCBB names trade only sporadically, spreads need to be wider than on Nasdaq stocks, for instance. Otherwise, dealers won't take on potentially money-losing positions.

"If I buy 20,000 shares of Apple, I can usually get rid of them fairly quickly at a price not much different than at what I bought them," he said. "That's not true with the majority of stocks in the OTCBB."

Gregg Dudzinski, who is in charge of trading at wholesaler Wm. V. Frankel, says his firm is not opposed to the BBX. But he's worried its introduction could lead to the same type of problems besetting the Nasdaq market in the SuperMontage era.

The BBX would likely usher in the ADF and ECNs, causing the market to fragment and lead to the scourge of locked and crossed markets, Dudzinski says.

Markets are said to lock when the best bid equals the best ask, and to cross when the bid exceeds the ask. "We're not saying BBX is a bad idea and shouldn't be done," Dudzinski said, "but we have a certain trepidation about the unintended consequences that could come of it."

Dealers also question Nasdaq's decision to implement SuperMontage as the BBX's central trading mechanism [see Traders Magazine, April 2003].

As for the Pink Sheets, dealers generally laud the venue as an efficient trading medium. They praise the real-time nature of EQS and the speed engendered by the recently launched Pink Link order delivery system.

But some worry that liquidity could dry up in some stocks. Brokers and investors may shun some of the stocks that fall to the Pinks if they perceive their quality as inferior to stocks on the OTCBB. "Without a doubt it's a concern," said one trader who did not wish to be identified. "I hope that doesn't happen, but I don't doubt it probably will. You will definitely see a little reduction in liquidity."

Andrew Berger, the publisher of Walker's Manual of Unlisted Stocks and a microcap investor himself, agrees. He says the perception of the quality of Pink Sheets securities causes investors to sell off even sound OTCBB stocks when they drop to the Pinks. "Frequently, when something goes Pink, voluntarily, as opposed to being de-listed, the stock price will take a big hit."

Dealers and others also fret over the impact on the future capital raising abilities of the thousands of companies that could drop to the Pinks. The cost to raise capital may increase, or the companies may not be able raise capital at all. Once again, some investors and bankers may shun the stocks because of a perception of lower quality.

"This change will force the little guy even further down the chain," said Dudzinski. "This will have a tremendously negative impact on the capital formation process for small companies."

One trader who left the industry a few years ago, but trades for his own account, wrote in an e-mail: "I have seen the destruction that Nasdaq has caused these companies. Not only do shareholders lose out but so do employees when these companies are forced to go to the Pinks or back to being private due to lack of capital raising abilities."

Aura of Respect

Pink Sheets maintains the quality of its companies is little different as those on the OTCBB. Companies quoted in the OTCBB, Pink Sheets execs say, have always been cloaked in an aura of unwarranted respectability due to the association with Nasdaq.

"Investors get misled by OTCBB's relationship with Nasdaq and the NASD," said Coulson. "That's why the Pink Sheets are different. Our brand name represents opportunity and risk."

Investors know what they are getting into with the Pink Sheets, according to Coulson. They may not with OTCBB issues. That OTCBB-quoted companies must file reports with the SEC is "not a high hurdle," Coulson said. "The number of suspensions by the SEC is pretty evenly divided between Pink Sheets and OTCBB securities." The SEC will suspend a company's stock from trading for ten days for various reasons.

For Mark Borelli, a former enforcement official at the SEC, the issue is less about the reputation of the securities quoted in the Pink Sheets than the regulatory oversight of the quoters.

Borelli, now an attorney with Shevsky & Froelich in Chicago, maintains surveillance is more aggressive in the OTCBB because the venue is operated by Nasdaq, an SRO, or self-regulatory organization. Pink Sheets is not an SRO. It is a non-exclusive SIP, or securities information processor, under securities law. It possesses no regulatory functions.

Borelli is opposed to a mass dumping of securities onto the Pinks and contends that Nasdaq or the NASD, have an obligation to continue to provide a venue for securities not listable on BBX. "Is an exchange a for-profit enterprise run for the benefit of its owners or is it a public trust?" he asked. "That's the bigger issue."

Nasdaq is clearly acting as a for-profit entity, Borelli says. OTCBB is neither good for Nasdaq's reputation nor profitable. By retaining only those OTCBB companies that can afford to pay listing fees it can turn a subsidized venture into a profit-making one.

"If Nasdaq is a public trust then maybe the fees from the other companies should be used to subsidize this market," the former regulator said, "instead of abandoning this market just because it is not profitable."

The OTCBB is a better marketplace because it is regulated more closely, according to Borelli. "That is key," he said. "If a market develops to replace OTCBB where at least the trading is regulated, then investors will be better off."

Pink Sheets does not regulate. But market makers quoting in the Pinks must obey the same rules as those quoting in the OTCBB. For example, they both have 90 seconds within which to report trades; must maintain firm quotes; and must file Form 211s to sponsor a security.

In theory the NASD is watching. Yet the regulator didn't win SEC approval to monitor EQS quotes until March. For the past four years, it has had a fuzzy arrangement with the Pink Sheets to receive EQS data.

"It shouldn't be fuzzy," said Borelli. "It should be clear. There is a vacuum that needs to be filled. Because of concerns over manipulation there needs to be a market for these orphan stocks where the trading is regulated."

Two names are mentioned as possible candidates to fill any perceived void between BBX and the Pink Sheets. One is ArcaBB, an alternative trading system formerly known as GlobeNet. ArcaBB is owned by Archipelago which runs the ArcaEx stock exchange in conjunction with the regulators of the Pacific Exchange. The other is the ADF, a quotation system run by the NASD in competition with SuperMontage for the quoting of Nasdaq stocks.

Under its previous ownership, ArcaBB did not make much headway in the trading of OTCBB names. It functions in similar fashion to an ECN on Nasdaq, but with considerably less success than such ECNs as Island or Instinet. In a recent month, it traded only a small fraction of OTCBB volume, according to the OTCBB website. But as part of Archipelago, one of the three largest ECNs, it could potentially tap into large sources of order flow.

The ATS has no immediate plans to build a marketplace based on dealer sponsorship of quoted companies, but is seeking to boost its liquidity in OTCBB names. "We want to capture market share before Nasdaq has a chance to de-list a significant portion of the OTCBB," said Tom Wilkerson, an ArcaBB exec. "We want to trade them all. We want to give the OTCBB stocks representation."

Still, Wilkerson says he gets calls from market makers interested in filing their Form 211s with ArcaBB rather than Nasdaq. In order to sponsor a company for trading in the over-the-counter market, a dealer files a Form 211 with either OTCBB or the Pink Sheets.

Wilkerson says that, given Archipelago's exchange status, ArcaBB has "a little more leverage on the Street" than its competitors. "We can do some things the other ECNs cannot," he said. ArcaBB's only competitor among the ECNs in the over-the-counter market is Track ECN.

"If the BBX forces us into our own corner and market makers don't want to participate in BBX," he added, "what is to stop Archipelago, because of its status, from creating its own marketplace?"

Carrying the torch for the ADF is Nick Niehoff, an ex-Nasdaq executive who launched the OTCBB in 1990 and is now under contract to Track. Niehoff is running a grassroots campaign to convince the powers-that-be in Washington that the ADF should broadcast quotes in OTCBB as well as Nasdaq names.

The ADF was mandated by the SEC as an alternative to Nasdaq's SuperMontage. It has become the primary quote outlet for the giant ECN Instinet. Like the OTCBB and the EQS, the ADF is simply an inter-dealer quote service, albeit one associated with an SRO.

For Niehoff, the ADF is a better venue than the Pink Sheets for the thousands of potential OTCBB orphans because of the quality of the existing Pink Sheets companies. "Most Pink Sheets companies aren't SEC-reporting," Niehoff said. "It's a quality of market issue."

Niehoff wants to see quoting and trading in any orphan stocks done in association with an SRO. His campaign involves writing letters to the NASD, promoting his plan to regional stockbrokers and working with the Security Traders Association.

Mark Madoff, co-head of the STA's primary Trading Committee, acknowledges the committee is in the process of setting up a sub-committee to evaluate the issues surrounding BBX.

Despite the opposition, Pink Sheets is pushing ahead with plans to make it easier for market makers to quote OTCBB securities in the Pinks. Right now most OTCBB securities, but not all, can be quoted in the Pinks as well as the OTCBB. Coulson says only about 860 of the 3,200 OTCBB are not eligible for dual quoting. He expects that number to drop to 600 soon.

Two of the largest over-the-counter dealers, Knight Trading Group and Schwab Capital Markets, are in the process of qualifying all their OTCBB names in the Pinks in advance of the BBX. Ponzio of Hill Thompson says his firm has always dually quoted a large number of its stocks.

Dealers which dually quote OTCBB names do so for any of three reasons: to advertise their interest more widely; to protect themselves in case a stock is de-listed from the OTCBB; and to use Pink Link. Generally, they do not quote prices and sizes in the EQS, but just their market maker IDs.

"Dual-listing is starting to take off," said Coulson. "Schwab, Hill Thompson, Knight, Monroe and Carr are dually quoting everything they can."

If the U.S. stock market was a cherry pie, the over-the-counter market would be one of five slices. There's the New York Stock Exchange; the American Stock Exchange; the regional exchanges; Nasdaq; and the OTC.

Technically Nasdaq is part of the OTC, but is generally considered a separate and distinct market – a de facto stock exchange. By most accounts, the OTC is split between two quoting venues: Nasdaq's OTCBB and the Pink Sheets.

The OTCBB has the better reputation of the two. That's because of its association with Nasdaq and its modest requirement that companies file with the Securities and Exchange Commission. Pink Sheets has no standards.

The OTCBB is sponsored and regulated by the NASD and run by Nasdaq. The Pink Sheets is a private company previously known as the National Quotation Bureau. The entire over-the-counter arena is littered with risky, financially dubious issues. Many trade in fractions of a cent. Both venues operate inter-dealer quotation systems. Pink Sheets also operates an order delivery system. Neither group "lists" securities as do the exchanges and Nasdaq. They require market makers to vouch for the securities they trade.

The combined volume of the two OTC venues averages about 1.3 billion shares per day. That compares to Nasdaq's one billion shares. Dollar volume, though, is a different story. Combined, the OTCBB and Pink Sheets record $193 million per day, just one percent of Nasdaq's $16 billion daily. The large number of penny stocks traded over-the-counter accounts for the difference.

Pink Sheets LLC began life in 1913 as the National Quotation Bureau, a publisher of securities prices. Until 1971, when Nasdaq came into existence, the pages of the Pinks were the only medium for distributing quotes of over-the-counter securities. The 300-page bound volume carried prices for about 11,000 securities on a daily basis.

Nasdaq eliminated much of the Pink Sheets raison d'etre, but it was not until 1990 when Pink Sheets came close to irrelevancy. That year the OTCBB was born. OTCBB broadcasted in "real-time" the quotes of about 4,400 Pink Sheets securities. Securities exclusive to Pink Sheets then declined to about 1,000.

In 1997, NQB came under new ownership. Its new management changed the name to Pink Sheets and built an electronic quotation system that complemented OTCBB.

During the 1999 to 2000 period, Pink Sheets began to regain its former clout. That's when Nasdaq stopped distributing the quotes of about 3,000 securities that would not meet new higher standards. Pink Sheets gained about 3,000 securities, bringing its total to 4,000. That number could shoot to 7,000 with the launch of BBX.

It's no surprise Nasdaq is looking to upgrade its OTC offering. The OTCBB is not profitable, sources say, and it has had a shady reputation.

Indeed, Nasdaq has always taken pains to distance itself from the OTCBB. Its website states: "The OTCBB is a quotation medium for subscribing members, not an issuer listing service, and should not be confused with the Nasdaq Stock Market."

The OTCBB website states, it is "separate and distinct from the Nasdaq Stock Market." That's despite the fact that Nasdaq operates the OTCBB's technology.

The OTCBB is considered by some to be a Wild West of easily manipulated securities, a reputation Nasdaq is determined to avoid. Nasdaq has even reprimanded OTCBB companies for issuing press releases stating their securities trade on "Nasdaq's OTCBB."

The OTCBB is sponsored and regulated by the NASD and operated by Nasdaq. The NASD was largely forced to create the OTCBB in 1990 by the Securities and Exchange Commission. That was following the passage of the Penny Stock Reform Act.

The purpose was to bring transparency to the non-Nasdaq section of the over-the-counter market. Previously, prices could only be found on the pages of the Pink Sheets distributed to dealers. The relative lack of transparency made fraud easier.

The National Market System for trading listed securities has worked well since the 1970s. That's because the NMS has effectively combined the price discovery benefits of an auction market with the competitive pricing structure of the dealer market.

There are two elements in this success. The first is the dissemination of national best bid and offer information. The second is the linkage of all market centers by the Intermarket Trading System, a system supported by clear rules and resolution procedures.

These principles of market structure have fostered the widespread availability of market information, as well as best price execution for all market participants.

There is general agreement about the importance of widely disseminated NBBO information. The debate is mostly about the efficiency of linkages between market centers. The ITS is criticized as slow. Critics charge it doesn't effectively link market centers with disparate models. Still, on average, 70 percent or more of commitments to trade are filled by the receiving market. And of the remaining 30 percent, cancellation of these commitments is typically the result of a quote change or stock trading prior to the arrival of the commitment.

There is merit in some of the ITS criticisms. However, any conclusion that eliminating ITS would improve the ability of the NMS to achieve its goals must be rejected.

What exactly are the strengths of ITS?

First, ITS is effective. It provides investors with the best price without regard to the market center to which their carrying broker routes that order. Although most orders are executed at, or within the NBBO at the receiving market, on average markets trade with each other via ITS over 35,000 times per day – to provide best price execution to a customer order.

Second, the availability of ITS reduces the incidence of locked and crossed markets. While it is possible to lock or cross a market in the NMS, ITS rules give the locked market an efficient vehicle to obtain a level of relief from the locking marketplace.

Finally, ITS not only protects customers, it also provides an incentive to enter limits at, or better than the NBBO. Although there is no cross-market time priority, ITS resolution procedures act as a measure to prevent one market executing trades at prices inferior to bids or offers displayed at other markets. ITS linkage and rules assure that, if a trade-through does occur, the customer will be satisfied. If these did not exist, there would be reduced incentive to submit limit orders that improve the existing NBBO.

The adoption of decimals have left traders increasingly frustrated with the slow turnaround time of the ITS. Users have responded by ignoring quotations for what they consider to be insignificant size, causing trade-throughs for relatively small share amounts.

Nevertheless, most of this frustration could be eliminated if all markets would agree to automatically execute inbound ITS commitments of 1,000 or fewer shares. Analysis of ITS trade-throughs suggests that a significant percentage is for 1,000 shares or less. That's the retail size order that the NMS was designed to protect. This single enhancement to ITS would dramatically reduce the friction and expense involved in handling small commitments orders. It would allow users to focus on efficiently pricing larger orders that might need to be filled at multiple price points. Limiting reform to 1,000 shares would have numerous benefits. It would allow markets actively engaging in price discovery for larger orders to continue to offer the benefits of an auction market process for orders operating in their (primarily) existing, manual mode.

Most of the stock quotations that make up the NBBO are for 1,000 shares or less. This is the same automatic execution level which would work for ITS. Most of these quotations represent the interest of retail investors. This group is most reluctant to recommit to the equity market today. Any proposal that weakens price protection for limit orders entered by these investors, or reduces their access to the best available price in the NMS, goes in exactly the wrong direction.

David Herron is CEO of the Chicago Stock Exchange.

Economist and investment strategist A. Gary Shilling's

eponymous firm is based just west of Wall Street, in leafy Springfield, N.J. Not far away, but manifestly far enough for Gary to maintain the fierce independence and creativity of thought that have distinguished a long career built on introducing fresh insights and perspectives -most often spiced with healthy dashes of humor-to not-always-the-most-flexible institutional and corporate types.

Which means I was an easy audience. -KMW

Congratulations, Gary-25 years is quite a milestone for an economic research firm. Particularly one led by a fellow who frequently makes a point of going against Wall Street's grain-

I don't deny being willing to look at things in unconventional ways. Maybe it has something to do with the fact that I was a physics major as an undergraduate, which makes you a math major as well-whether you want to be or not.

That definitely means you were certifiable, but whether it permanently skewed your perspective, I don't know.

Me, either. But I do know that the markets discount the consensus view. Therefore, the only way you're going to add value is to find something that's new, very strange and exotic. Now, there's a fine line between taking a contrary position for the sake of notoriety and genuinely seeing something that the herd doesn't. But where we see something we think has a good chance of happening that is not in the consensus, we try to jump on it with all fours. Of course, one of the drawbacks is that you are usually talking about things far out on the horizon, so that by the time they happen, the media- and even some clients – have pretty much forgotten you have ever forecast it.

For instance, you've been writing for quite a while about some of the themes, like "20 Follies" that created a stir when Peter Bernstein gave a speech about similar lessons of the mania in January.

Exactly. Some I even put in my Forbes columns.

But you've got to be used to the fickle finger of Wall Street. How many times were you fired by Merrill Lynch?

Twice, and by the same fellow-not that I was trying! But Merrill ended up acquiring the firm I had gone to!

Proving, if nothing else, that you don't have perfect foresight! But aren't you risking being right but irrelevant when you get out too far ahead of the herd? Especially since a lot of investors think tomorrow is long-term?

Well, we try to alert institutional clients to what we think may happen. Not with the idea that they're going to take action immediately, but so, if they start to see signs, they'll be able to move faster than the crowd.

Deflation and a painful recession have been hallmarks of your outlook at least since your book ["Deflation: Why it's coming, whether it's good or bad, and how it will affect your investments, business and personal affairs"], came out in 1998. Yet most folks still blame 9/11 for last year's relatively mild downturn-

Funny, that recession started, I believe, in March 2001, and 9/11 didn't happen until that September, obviously. Meanwhile, most forecasters just don't see a double dip at all here. Because, first of all, they start out with a tremendous bias. As I know from my own experience, negative forecasts can shorten your job tenure tremendously.

So why risk the dour prediction?

It really is a question of how much weight you put on a retrenchment by consumers. I think the evidence is certainly in our favor. We're seeing a rapidly rising saving rate, weakness in auto sales, retail sales-

New consumer confidence numbers just came in with a big bounce-

The irony is that this was the largest jump in consumer sentiment since 1991-a jump that occurred right after the first Gulf War ended in victory. You might recall that it didn't last; that it, too, was a jobless recovery, and that the original President George Bush ended up winning his war but losing the next election because of the economy. Meanwhile, today, initial jobless claims just get worse and worse and the weekly economic flash numbers, post-this-Iraq victory, are not inspiring, either. Wal-Mart's sales came in at the low end of their range, weekly leading indicators are down. There's nothing to suggest that things have come alive. The interesting thing is that the bull model is that consumers are going to hold the debt-laden fort from being overrun by the Indians until the capital spending cavalry rides to the rescue. But in actual fact, capital spending is a lagging series. We've done some work on it, and it's really capacity utilization that pushes capital spending. Until that gets up, you're not going to see much. So capital spending is more the rear-guard chuck wagon than the hard-charging cavalry. Which makes the question whether the consumer has enough umph to create an economy strong enough to induce capital spending.

And the answer is?

I don't think so. It looks like housing is starting to crack and like consumers are using a lot of the money they are getting from refinancing to pay down credit card and other debt rather than for new spending. What I see here is a retrenchment. Yet historically, there just haven't been many economists willing to forecast a recession until the thing was staring them in the face. They wait until the stock market collapses and then say maybe a recession is in the cards. For investors, that's about as handy as a pocket in their underwear.

And now?

We've got vulnerability in housing and consumer spending.

You're well outside of the herd when you mention "vulnerability" and housing in the same breath.

That's true. Our rationale rests more on the guy on the bottom. The people who have bought into housing with 3 percent or less down payments; taken advantage of government efforts to get low-income people to become homeowners. The theory is that low-income home ownership helps create more stable families and neighborhoods.

You've heard [Fannie Mae Chairman Franklin] Raines' stump speech, too?

Yes. But it's not just Fannie. It's also HUD, Freddie, etc. My point is that our research shows that most people in these low-income categories (up to about $20,000 in income) have negative net worths. Their debts- mostly credit cards-exceed their assets. So if we are right about this second dip, and they lose their jobs, these new home owners with these low down payments are in trouble, as are prospective ones. Which won't exactly do wonders for the move-up market, where I think the vulnerability is. This is a nationwide phenomenon in terms of a lot of low-income people really balancing on a knife's edge. Everything has to go right for them to be able to service their debts. But the auto companies are probably the best candidates for subprime loan problems, with all their zero percent financing offers. Who can blame a guy for saying, "Hey wonderful, I'll take it." But when his first bill arrives, six months down the road or whatever, does he mail in a payment-or mail in the keys? We're going to look back and see that subprime lending was a tremendous systemic problem.

Okay. Now what?

Let me emphasize one very important thing: A lot of bears on the market and the economy fear the bad deflation of deficient demand, the deflation that spins out of control, as in the 1930s and in Japan today. That's not what I am forecasting. I'm talking about very moderate deflation, the good deflation of new-technology-driven excess supply. The sort of thing that happened in the late 1800s and during the Roaring 'Twenties, in other words. But yes, the history of deflation is a history of peace and the history of inflation is war.

So deflation is yesterday's threat?

No. I'm assuming that whatever happens politically, Iraq is not going to be that big a factor in ballooning government defense spending. Defense spending was about 7.5 percent of GDP during the Cold War. It's come down now as low as 4 percent. It's moved up a little now, but I'm assuming we won't have anything like 7 percent.

So investors will have to learn new lessons?

Yes, the whole very long bull market, (17 years, eight months), was caused by the unwinding of inflation. Not that there weren't other aspects: the end of the Cold War, etc. But the unwinding of inflation was very good for P/Es because it was pushing down interest rates, pushing up growth rate estimates and lowering the rate at which they were being discounted. Although they got out of hand, it also was very good for corporate earnings: It lessened and now has eliminated government taxation of inventory profits and under-depreciation, if you're familiar with those concepts, which have almost dropped out of the lexicon. So we saw a huge increase in profits' share of GDP from about 3 percent to 7 percent in the mid-'80s and late '90s. Meanwhile, the stock rally amounted to 15.3 percent compounded annually, from the July low in 1982 to March of 2000. So half of it was really a P/E play and half of it was the profits improvement. My point is that we've just been through an extraordinary period. But people, by the late '90s, thought that's the way God made the world.

When in fact reported profits numbers were turned into hokum, by managements that ran out of low-hanging restructuring fruit to harvest for the earnings "growth," but wanted, above all else, to push their options into the money.

Yes. The downside targets that we set in November of 2000, just looking at P/Es and price to book and price to cash flow and market cap to GDP and all that stuff, with Nasdaq down 70-80 percent, the S&P down 40-50 percent and the Dow, off 30- 40 percent. Well, they have all fallen into those ranges. But I'm not sure you've seen the bottom because we were basing those targets on "earnings" at that point. And we've seen subsequently a collapse in earnings-and learned that a lot of what we thought were earnings back then were phony baloney. So the situation is that despite these huge declines, stocks still aren't cheap. And people still have to unlearn the lessons of the bull. As Peter Bernstein pointed out to you, S&P profits grow more slowly than the economy. Why? Because they don't include a lot of young start-up companies that are not listed stocks; that are not even public, in many cases. So to expect the bull to live forever was not realistic.

Nor can P/Es grow to the sky?

Right. It seems to me that you've got to have some premium to the earnings yield (the inverse of the P/E), on Treasuries. So if I am right, and we get mild deflation of 1-2 percent, you could see long Treasuries at 3 percent. That would be a 4-5 percent real yield, which is actually low by historical standards, if you go way back. It's not low, by post-war standards, but I think the post-war period wasn't really typical. In any event, 4-5 percent real rates on long Treasuries with 3 percent stock yields and 1-2 percent deflation, wouldn't be bad. That's almost twice post-war standards. If you take that 3 percent and add 1 percent for the risk premium on stocks versus bonds, you've got a 4 percent earnings yield. And if you invert that, you've got a 25 P/E. Which is about where P/Es are today-but that's based on a forecast of Treasuries going to 3 percent.

Not exactly the consensus. What if you're wrong, and the herd somehow gets it right?

Okay, say Treasury yields go back up to 5-6 percent, and you add 100 basis points to that to come to 7 percent. You invert that, and you've got a 14 P/E, vs. now close to a 30 P/E on a trailing 12 month basis. We did some simulations on this and you've got to see just literally unbelievable profits growth or a huge further big stock decline-or both-to really accommodate the consensus view. The irony is that our forecast of mild deflation is much more hospitable to stocks from here than is the consensus view.

But the herd doesn't get it.

No. I keep hearing that certain stocks are "cheap," just because they've come down a lot. I still hear that investors should buy and hold; not try to time the market, even that being out of stocks is a losers' game. Yet way back in 1992, I wrote an article for the "Financial Analyst's Journal," looking at the post-war period, which found that even if you're out of stocks during bear markets, and even if you miss the best of the blow off phase of the bull market, you're still better off.

Which brings up the issue of investment fees. The fat years are over, you've said?

The irony is that now people are belatedly deciding they can't invest on their own a lot of people are very ripe to have their money professionally managed. But with the kinds of returns that they can reasonably expect, maybe 4 percent (and most of that from dividends) on stocks, 3 percent on bonds (or a couple of percentage points more if you accept the consensus view), it just won't fly to pay investment management fees of 3 percent or even 2 percent. So it will be interesting to see if the Street's traditional leaders will be flexible enough to change with the times.

It certainly implies that stocks still aren't cheap, enough.

And puts the lie to my favorite bull market fallacy, the notion that Treasury bonds are for wimps who are too timid and too stupid to grasp the wonderful world of stocks.

Don't you know that the next move in interest rates has to be up? You're not suggesting rates go to zero, are you?

Well, they aren't there yet. But people believe it is engraved in stone that they're going up from here. If the best you can expect on stocks going forward is about 4 percent, and if you can get 3 percent on long Treasuries, that favors bonds on a risk-adjusted basis. Certainly, deflation favors bonds. We're now close to 5 percent on a long Treasury. If we go to 3 percent, and let's say that happens over two years, you pick up two years' worth of interest (roughly 10 percent, at 5 percent a year), and you have a total return of about 50 percent. If you have a 30-year zero coupon bond, you'll have total return of about 80 percent over that period.

Those are awfully big numbers, considering how low nominal rates are-and even stranger, imply that the retail masses who've been piling into bond funds are doing something right for a change.

Stranger things have happened-for a while. As for the size of those potential returns, they're partly the result of compound interest. Also, again, simple math. Rates dropping by 100 basis points from 15 percent or whatever they were at the peak in 1981, doesn't produce huge appreciation in percentage terms. But if rates go from 5 percent to 4 percent, the appreciation on a zero is about 33 percent. Anyway, we were lucky enough to declare back in 1981 that we were entering the bond rally of a lifetime-and I think it's still intact.

Surely, though, it's awfully close to peaking-

Just like the long bull market in stocks did in its manic stage, I think the staying power of the bond bull will confound people trying to call the top. There are other things, besides the dawning disappointment in the returns on stocks, that are going to push bonds up. Not the least of which is what is happening with defined benefit pension plans, now that it's becoming clear that they aren't a steady source of pre-tax profits for their corporate sponsors. The actuarial complexities are practically impenetrable. What it comes down to is that companies have been taking advantage-to varying degrees-of the fact that they are allowed to set assumptions not only for their gains on stocks and other investments, but on the interest rates they use to discount their liabilities-

But none of those "profits" in any way benefits shareholders. Nor, in most cases, will they contribute anything towards actually paying future claims by retirees-something pension plan trustees might start getting a mite edgy about, if the stock market doesn't ride to their rescue soon.

That's right. What a lot of people don't realize about all the assumptions the pension funds make is that the regulations only give them so much leeway. As long as their assumed returns and actual results are within a 10 percent channel, they're okay. But if you get one nickel outside of that channel, then you've got to amortize the whole difference. And that's quite a time bomb. The upshot, I believe, is that you'll see a lot of defined benefit pension plans doing a lot of dramatic asset allocation rebalancing. Most investors, even sophisticated investors, understand very little about bonds. Yet I believe one of the big changes we're facing is that managers are going to be hired first and foremost to make money. Beating a benchmark is going to be secondary. People are going to give a lot more discretion to managers in terms of holding various classes of stocks, even holding bonds and cash-as long as they make money. But the fact is, you're going to have to be out of stocks at some points. In them, at others. You're going to have to risk losing your shirt because bear markets are more volatile than bull markets. The uncertainty principle says you can never exactly measure both the position and the momentum of a subatomic particle, because the very act of measuring it changes it in subtle ways. In other words, you can't pinpoint the exact location of something without changing it in an unpredictable way.

Thanks, Gary.

Kathryn M. Welling is the editor and publisher of welling@weeden, an independent research service of Weeden & Co. L.P., Greenwich, Conn. http://welling.weedenco.com