The SEC’s settlement with NASDAQ in late 1996 will almost certainly impact trading and price improvement in a favorable way for small investors. The settlement resulted in rule changes that are intended to improve greater access to the market for individual investors, and to improve the display and execution of orders. The changes will be implemented in several phases, with the first phase beginning on 10 Jan 1997. Initially only 50 stocks will be in the program, but in subsequent steps in 1997, the number of stocks will be expanded to cover all NASDAQ stocks.
This action began after many people complained about very high spreads in some shares traded on the NASDAQ market. In effect,the SEC contention was that some market makers possible did not publicly post orders inside the spread because it impacted their profit margins.
Here are some of the key changes that resulted from the settlement.
- All NASDAQ market makers must execute or publicly display customer limit orders that are (a) priced better than their public quote or (b) limit orders that add to the size of their quote.
- All investors will have access to prices previously available only to institutions or professional traders.
These rules are expected to produce more trading inside the spread, so wide spreads may become less common. But remember, a market maker or broker making a market for a stock has to be compensated for the risk they take. They have to hold inventory or risk selling you stock they don’t have and finding some quickly. With a stock that moves about or trades seldom, they have to make money on the spread to cover the “bad moves” that can leave them holding inventory at a bad price. Reduced spreads may in fact force less well capitalized or managed market makers to leave the market for certain stocks, as there may be less chance for profit.
It will definitely be interesting to see how the spreads change over the next few months as the NASDAQ settlement is phased in on more and more stocks.
Article Credits:
Contributed-By: John Schott, Chris Lott