NEW YORK-Recent Securities and Exchange Commission censure of Nasdaq, a stock market that lists many wireless-related companies, is just one of several drivers of significant changes ahead for the financial services community.
As already has happened in the telecommunications industry, so too will technology advances, federal regulatory changes and foreign competition promote transformation in the ways capital is raised for publicly held companies.
The firestorm sweeping the stock exchanges, both here and abroad, is comparable to the natural phenomenon of forest fires, on which certain species of trees depend to pop open their seeds for regeneration, said Harold S. Bradley, director of equities trading for Twentieth Century Funds, Kansas City, Mo.
“If I were an issuer, I wouldn’t bolt Nasdaq because, with the changes, Nasdaq will be the stock market for the next 100 years,” Bradley said. “I would get involved in NASD (National Association of Securities Dealers) committees because issuers and institutions have been the components missing from all the debates.”
The rapidity of this transition could result in some unexpected and undesirable outcomes, which will have to be dealt with, Bradley conceded. But overall, he and other advocates of reform sound much like supporters of multiple players and technologies in the wireless communications industry who see their market expand as competition decreases unit prices. Fairer, faster, clearer and more accessible information for everyone buying and selling stocks will lower the cost of capital and increase its availability to issuers, not least because it will encourage more individual investors to buy stocks.
Individual investors, along with pension funds and institutions hold about 85 percent of the $7 trillion in total outstanding equities. That estimate comes from an analysis of the Federal Reserve Board’s Flow of Funds Report prepared using first-quarter 1996 data by the Investment Company Institute, Washington, D.C., said Chris Wloszczyna, a spokesman for the mutual funds association. The remainder is held by mutual funds.
“I think the changes (on Nasdaq) will have a positive effect. It will cut down on the spreads. It will be a more competitive market. Individual investors will get better executions and prices. With more exposure to information, there will be more activity,” said Steven Banalett, vice president of a retail brokerage firm in New York.
Spreads are the price differentials between the highest bid a prospective buyer of securities is prepared to pay at a given time and the lowest acceptable price asked at that time by the issuer of those securities. On Nasdaq, market makers are the dealers who maintain firm bid and ask prices by being prepared to buy or sell round lots of securities at publicly quoted prices.
“Companies like ours take significant risks in making markets, and I’m not sure the regulators understand this,” said Hugh Johnson, chief investment officer, First Albany Corp., Albany, N.Y.
Dan Weaver, professor of finance at Marquette University’s College of Business Administration, Milwaukee, offered a countervailing view. “One of the things we expect is investment banks that also are market makers will experience lower margins offset by greater volume,” he said. “The other is that there will be less price volatility with tighter spreads.”
In December 1994, Weaver and David Porter, then also a professor at Marquette, published a paper titled, “Do Nasdaq Market Makers Paint the Tape?” In the trade, painting the tape means manipulating the market. “Using access to transactional databases, we found this was 13 times more prevalent on Nasdaq than on all the other organized exchanges together.”
That isn’t to say that the New York Stock Exchange is blameless by comparison, in the view of Bradley of Twentieth Century Funds and Robert A. Wood, distinguished professor of finance at the University of Memphis in Tennessee. “NYSE itself is in dire need of reform,” said Wood, a member of NASD’s Economic Advisory Commission. “You could design an exchange that is more efficient than both NYSE and Nasdaq, although measuring efficiency is tricky.”
Both Wood and Bradley said European exchanges, like those in France and Sweden, have reduced institutional barriers to competition, seen their trading costs drop and their volume of shares traded increase. “The security market line, the ratio of risk to return, defines the cost of capital,” Wood said. “If you can reduce trading costs, you lower that line and more projects become profitable, so the number of initial public offerings would increase.”
Besides competition and regulatory changes, advances in technology that make increasing amounts of information available to more people are helping to propel the transition to more open and egalitarian markets, they said.
“The invisible hand is moving with incredible pressure and increasing rapidity,” Wood said.
