SEC Study: Investors Often Pay Less to Trade on NYSE Than Nasdaq

Investors are able to purchase stocks of all but the largest companies for less on the New York Stock Exchange than on the Nasdaq, federal securities regulators said in a study released Monday.

That's because the "spread," or the difference between the price asked for a stock by sellers and the price bid for it by buyers, is significantly higher for small and medium and some large stocks on the Nasdaq than on the NYSE, the Securities and Exchange Commission concluded.

Nasdaq immediately criticized the report's methodology, but also said the study showed that greater competition for stock-order execution -- which it claims to provide investors -- produces lower costs.

The SEC's analysis also found that for the largest stocks traded on the two exchanges, the bid-ask spreads were statistically the same. Furthermore, the SEC found trading occurred more rapidly on Nasdaq for orders in quantities of 100 to 499 shares, although that advantage disappears for larger quantities.

"If the study does nothing more than increase pressure on both markets to respond to the longstanding demands of investors, it will have served the public well," SEC Chairman Arthur Levitt said in a prepared speech delivered at Stanford University Monday evening.

"For Nasdaq, it confirms a challenge it faces and quantifies what most traders freely acknowledge -- the ability to trade inside the best-displayed quotes is substantially limited," Levitt said. "For the NYSE, it sheds further light on the time it takes for incoming orders to interact with trading interest on the floor."

The Key

Nasdaq President Rick Ketchum said the SEC report's finding that spreads for the largest stocks were roughly the same on Nasdaq and the Big Board suggests that competition for orders is the key for trading costs. The largest stocks in terms of market capitalization are handled by a greater number of market makers -- firms that step in to purchase or sell securities at publicly quoted prices -- than medium and smaller stocks, he said.

"The more competition that exists to execute an order, the better the result for investors," Ketchum said.

On the Nasdaq, buyers and sellers are brought together electronically, and the trading is accommodated by market makers. At the NYSE, securities are bought and sold on a trading floor, in an auction process in which orders are handled by floor brokers and the trades arranged by specialist firms.

"Our agency-auction model offers the most efficient method of price discovery, leading to the lowest execution costs and best prices for customers," the NYSE said in a statement. "Increasingly but still not often enough, investors are empowered to decide where their orders are executed. Research such as this will help these decisions be informed choices."

Ketchum said the study's comparison of stocks traded on Nasdaq with those on the NYSE wasn't always "apples to apples." He noted that companies traded on Nasdaq tend to be "younger, less diversified, from quite different industries, and more growth-oriented than NYSE companies. Among these stocks, volatility of prices tends to be higher."

The Basics

The SEC based its study on data gathered during the week of June 5 to June 9, 2000, and included 221 stocks traded on Nasdaq and 1141 stocks traded on the NYSE. The study concluded the average spreads on all but the largest stocks on Nasdaq were 5.7 cents to 11 cents wider than those for comparable stocks traded on the NYSE. That equates into a higher cost of between $8.50 and $16.50 for a 300-share market order for those stocks on Nasdaq compared with the NYSE, the study said.

SEC officials noted that the study period occurred before the NYSE began changing trading in shares to increments of one penny instead of fractions of one-eighth of a dollar. Nasdaq won't begin converting to decimal trading until later this year. The conversion to decimalization is widely expected to help reduce the spreads between offered and bid prices, and SEC officials Monday noted that effect was not factored into their study.

Supporters of the shift to decimal trading, including Levitt, have long argued that the resulting reduction in bid-ask spreads would save investors money. The argument held that market middlemen buy securities at one price, sell them at a higher price and pocket the difference. The closer the bid and sale prices are brought together, the less the middlemen take out of the transaction.

SEC officials declined to draw conclusions from the study released Monday about how much market middlemen were making on the Nasdaq or NYSE.

Ketchum said Nasdaq believes a new Supermontage system it has proposed, which would display three available prices for stocks, would lead to better execution quality for Nasdaq.

Bid-ask spreads are just one indication of execution quality, and should be considered along with other factors such as speed of execution, liquidity (the availability of buyers and sellers for shares) and transparency, Nasdaq officials said.

The SEC has scheduled a meeting on Wednesday to decide whether to approve the Supermontage plan. "Supermontage will provide better prices for investors," Ketchum said.

>To order reprints of this article, click here: Reprints