At first blush, the proposed merger of the NASDAQ Stock Market and the American Stock Exchange seems like welcome news for investors. By creating a more formidable rival to the New York Stock Exchange, the linkage of the NASDAQ and the Amex could lead to more efficient markets. Combining the auction system of Amex and NASDAQ's dealer system could yield a hybrid electronic-auction market that would present new choices and potential cost savings for issuers, traders, and investors. "It's the catalyst that will lead to a complete reengineering of our markets," says Junius W. Peake, a professor at the University of Northern Colorado and a former National Association of Securities Dealers director.
Don't count on it. Introducing structural changes at the exchanges has often been an exercise in futility. Such efforts inevitably hurt the financial interests of entrenched Wall Street firms and trading-floor personnel by reducing their role as middlemen. If a new trading system does develop, as it has in London, the original design is likely to be watered down to make it palatable to vested interests--at the expense of creating a more liquid, open market that would benefit all investors.
Consider the tale of innovation interruptus at the London Stock Exchange. For years, the LSE had used market makers, as NASDAQ does. Then, in 1996, exchange officers at the LSE proposed creating a computerized auction system that would match buy and sell orders and be more efficient for investors. But once market makers realized that the system could deprive them of business, they, as owners of the exchange, voted out their CEO. Market makers now use the computerized system when they want to and avoid it when they don't. "London is run in many ways for the benefit of the professional trading firm," says Columbia University law professor John C. Coffee Jr., who is on NASD's legal-advisory board.
Most attempts to change U.S. markets have also failed. InterVest Financial Services, for example, was created as a trading system for the secondary bond market, which has no central posting of bids and offers. InterVest would post bids and offers electronically, allow instant execution, and give traders anonymity. The goal was a cheaper, more efficient market. But InterVest's founder says bond dealers refused to use the service since it usurped their role. InterVest is now trying to become an Internet-based system but has run out of money.
"DICKENSIAN." Proponents of the NASDAQ-Amex deal, which was approved by both boards on Mar. 18 and now awaits a vote by Amex members, say that it will merge the best elements of dealer and auction markets. But already that vision is getting blurred by politics. To get the deal done, Amex must convince floor brokers that they aren't voting themselves out of existence. So far, the brokers have been assured that the trading floor will remain for 10 years, that a new floor may be created, and that their jobs won't disappear. That's not progress. "Floor brokers are a 19th century Dickensian institution that still survives in an era of electronics," says Columbia's Coffee.
There are other innovations in the works--changes that also must overcome the human factor. For example, NASDAQ is proposing an electronic system developed by OptiMark Technologies as an adjunct trading system. OptiMark uses artificial intelligence software to help institutional investors trade large blocks of shares without revealing their strategy or identity--something that's not possible in the NASDAQ market. "NASDAQ is starting to understand how to create market systems that investors want," says Harold Bradley, a fund manager with American Century Investment Management. But OptiMark undercuts the role played by block trading desks, so it faces high hurdles.
It's another reminder that the stock exchanges are still run for the benefit of their members and securities firms, not for companies and their shareholders. Until that situation changes, deals like the Amex-NASDAQ hookup won't produce the gains investors expect and deserve.