A Magic Bullet for NASDAQ?

The weakened market hopes to blow away rivals with a powerful trading system, SuperMontage

On calendars at the Times Square headquarters of the NASDAQ Stock Market, Oct. 14 is circled in red. On that day, after more than three years of struggle, NASDAQ will roll out SuperMontage, the new, turbocharged trading system designed to attract heavier stock trading by giving brokers far more information about shares' supply and demand. NASDAQ executives confidently predict it will restore their market as the world's premier electronic stock trading site.

The next day, however, will see a very different message about NASDAQ's ambitions. That's when NASDAQ Japan will turn out the lights in Osaka. The Japanese market was hailed at its 2000 launch as the first link in NASDAQ's plan to span the globe with 24-hour trading and hot initial public offerings. Instead, it was doomed by the bear market and NASDAQ's hasty missteps.

Clearly, NASDAQ hopes to get back on track as a world-beater. But it could just as easily end up an also-ran on its home turf. For all its strengths, SuperMontage isn't likely to solve NASDAQ's No. 1 problem: the continuing flight of trading volume to electronic communications networks. Although NASDAQ is still the second largest stock market in the world, ECNs have captured 48% of trading in NASDAQ-listed stocks, more than twice the 22% executed on NASDAQ's own systems. (The rest are handled by brokers who match buy and sell orders without sending them to any market.)

If SuperMontage doesn't stop the ECNs, NASDAQ's global strategy, devised at the height of the tech boom, is unlikely ever to succeed. Most vulnerable: The market's plan to hold its own IPO and become a for-profit, publicly traded company early next year. "As a business, NASDAQ is facing strong pressure on all its sources of revenue," warns James Angel, a Georgetown University economist who has consulted for NASDAQ. "It's got to prove it's a viable investment."

Right now, it doesn't look like a good bet. The rout of tech shares that began in March, 2000, has laid NASDAQ's business low. The IPOs that created that NASDAQ buzz are off by 89% since the 1999 peak. With hundreds of companies defecting to the NYSE or shrinking into oblivion, NASDAQ now lists just 3,843 stocks--the fewest since 1983. Still, NASDAQ is reporting profits: $8.8 million in the second quarter after writing off $10.3 million for NASDAQ Japan. Without that hit, profits would have been down only slightly from the $19.6 million in the second quarter of 2001.

NASDAQ executives admit that what they really need is a rising market--but SuperMontage should give them a lift anyway. It "might be a category killer," says NASDAQ Chief Executive Hardwick Simmons. The new system will outflank the ECNs, argues President Richard G. Ketchum. "If they want to serve their customers, they'll have to link up with the biggest pool of traders, and that will be SuperMontage," he says.

The system is designed to out-ECN the ECNs, which lobbied the Securities & Exchange Commission hard to block or modify it. Like them, SuperMontage will allow a broker to post several quotes to buy or sell shares, not just one. Traders' screens will show how much stock is available at five levels of quotes, rather than just the best bid and offer prices as NASDAQ shows now. The system will also let brokers post anonymous orders to avoid tipping off the market when they're trying to buy or sell big blocks for pensions or mutual funds. And trades will be faster, thanks to expanded automatic execution.

Some experts think the changes will wipe out rivals. "This is the death knell for the ECNs," says Octavio Marenzi, managing director of Celent Communications, a financial-services consultant in Boston. If SuperMontage matches the ECNs' speed and information flow, "it will quickly drain their volume," he says.

But big traders want to keep the competition. Schwab Capital Markets, one of the biggest of the brokers who serve as market makers for NASDAQ, will use SuperMontage--but won't abandon ECNs, says Larry Leibowitz, head of equities. "It's not a good thing for us if SuperMontage sucks up all the volume," he says. ECNs have some powerful allies among institutions, who think SuperMontage favors NASDAQ brokers and will cost too much. "NASDAQ has layered on so many fees that its own greed will be its undoing," says John J. Wheeler, senior equity trading manager for American Century Investments in Kansas City, Mo. NASDAQ's Ketchum says some proposed fees have been dropped.

The ECNs aren't sitting still, either. The two biggest, Instinet Group (INET ) and Island ECN, are merging to combine their strengths--Instinet's appeal to big institutions and Island's core of active traders--and their 30.4% share of NASDAQ trading. "It would be surprising if investors decided to abandon the largest electronic player in the market," says Jean-Marc Bouhelier, Instinet's chief operating officer. Chicago-based Archipelago LLC is taking another course: Its system now handles trading at San Francisco's Pacific Exchange, allowing it to execute orders without going through NASDAQ's. Besides diverting trades from SuperMontage, both Archipelago and the Instinet-Island combination plan to squeeze NASDAQ by reporting their trades on other exchanges--thus claiming the revenue that NASDAQ otherwise would receive from reselling quote and trade data to brokers and investors.

SuperMontage's success is vital to NASDAQ overseas as well. In Japan, NASDAQ couldn't persuade hard-hit brokers to invest in the new system. But in Europe, NASDAQ will launch SuperMontage on Oct. 7 as the backbone of two markets: Brussels-based NASDAQ Europe, which promotes cross-border trading, and NASDAQ in Germany, which trades German stocks via an alliance with minor exchanges in Berlin and Bremen. The goal: to be poised for growth when a recovering economy brings back demand for NASDAQ's savoir-faire in launching emerging companies.

There could be a long wait. Until then, NASDAQ will have to count on SuperMontage to recapture volume at home. If it can't turn back the ECNs, global ambitions won't count for much.

By Mike McNamee in Washington

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