Nasdaq Will Revamp Trading System Next Week, for Shift to Decimal Trading

Setting the stage for trading in pennies, the Nasdaq Stock Market will revamp a key component of its SelectNet electronic trading system next week and will begin handling stock transactions in four separate systems instead of one.

The SelectNet change, in the works for months, is designed to increase the Nasdaq's capacity for electronic trades and messages, and accommodate a potential spike in volume driven by the shift to decimal trading.

And with it, Nasdaq says it'll be ready for the full conversion to decimals by the April 9 deadline set by the Securities and Exchange Commission, despite technological concerns that a year ago prompted Nasdaq to effectively postpone the change to decimals for the nation's markets -- and despite last month's urging by a trade group to slow the switchover.

"We have been upgrading our capacity continuously since last year," Nasdaq spokesman Scott Peterson says. "We are essentially sticking with the plan" put forth by the SEC. "We feel confident."

The change comes as Nasdaq handles a record volume of trades amid the year-long selloff in technology stocks.

Daily Trading Volume on the Nasdaq Market

Source: Nasdaq

Nasdaq's contention that's it's ready for decimal trading is endorsed by Bernard Madoff, owner of one the exchange's chief market-making firms, Bernard L. Madoff Investment Securities.

"Technologically, we're probably OK with this from the industry standpoint," Madoff says. "I'm very comfortable with Nasdaq's capabilities."

Pennies

When it shifts to decimalization, Nasdaq will offer stocks in increments of one cent, rather than the traditional fractions of 1/8 of a dollar.

Nasdaq, which matches buy and sell orders electronically in contrast to the New York Stock Exchange's system of arranging transactions on a trading floor, began a pilot demonstration with 15 stocks trading in decimals this week. It's scheduled to add an additional 199 issues on March 26 and convert trading for all of its 4,700 listed companies to decimals on April 9.

But the Security Traders Association, which represents the people who actually carry out the trades, isn't convinced.

The group fired off a letter to Acting SEC Chairwoman Laura Unger last month urging her to phase in the decimal change at Nasdaq more gradually.

"It is the sincere concern of many of our members that the current plan does not provide enough time to adequately test and assess the many technology and trading issues associated with the conversion, and we urge the commission to consider a less demanding implementation schedule," the group wrote.

The SEC, which rarely comments publicly on such appeals from interest groups, declined to comment on the letter. But the decimal deadlines haven't changed, an SEC spokesman says.

More

Nasdaq expects the shift to decimals to increase its daily message traffic and share volume by 7% to 8%, Peterson says. The exchange has spent about $120 million over the past two years on technology improvements for the shift, including the update of SelectNet, a system that handles about 26% of the exchange's daily share volume.

Peterson says Nasdaq is also closely watching its chief competitor, the NYSE, which began testing stock trading in penny increments last year and made the full conversion to decimals in January. That shift hasn't gone off without friction. It's attracted criticism from some institutional investors who've complained the penny trading increments make it difficult to place large orders.

In addition, studies also have found penny trading produced a reduction in stock depth -- that is, the number of shares of a given stock at a given price, which worries institutional investors.

The NYSE on Thursday announced that starting March 19, it'll issue "depth indications" for certain stocks, describing how many shares of the stocks are available at given price increments.

Studies of the early results of decimal trading at the NYSE also have found that the conversion reduced the so-called "spread" between the price offered by stock buyers and the price asked by sellers. Reducing that spread, proponents of decimal trading have long argued, helps investors save money because market middlemen, like market makers, are less able to capture profits between the bid and ask prices.

Spoiler

Nasdaq was the spoiler at the decimal dance a year ago, when the market was roaring and the Nasdaq Composite Index hit its all-time high of more than 5000 in March 2000. At the time, the exchange said its computer capacity would be overtaxed if it were forced to handle trading in decimals by the then-deadline of July 2000. The SEC, to the ire of some members of Congress, agreed to postpone the switchover as a result.

Despite the enormous drop in the Nasdaq Composite since then -- to below 2000 this week -- the volume of trading on the exchange has actually increased. In March 2000, an average of 1.9 billion shares were traded on Nasdaq each day. This January, the daily average was 2.4 billion. And so far this month, it is 1.97 billion.

Madoff says Nasdaq's caution in moving into decimals gives him comfort about the timing now.

"A lot of preparation goes into making these changes and these conversions," he says. "Historically, they have not done them unless they were ready."