WASHINGTON -- The
, a mutual fund company popular with small investors, makes it a practice to shun trading as the
Nasdaq Stock Market
fires up for the day.
"It's the most 'gamed' time of the day, so we stay away from the opening," says George U. Sauter, Vanguard's managing director. "It's the time when there can be the most manipulation. It's a great time for dealers, because they buy at very different prices than they sell."
Concerns like that have prompted consideration of new rules for how dealers trade before Nasdaq opens. Changes could mean small investors will get better prices when they buy and sell.
The potential new rules, now under consideration by an influential Nasdaq committee, would require Nasdaq dealers to give customers the benefit of any prices that the dealers themselves obtain before the market's regular 9:30 a.m. EDT opening.
On Wall Street, knowledge is indeed power. As trading has grown in recent years, and especially as many online investors have come to place orders in advance of the market opening, concern has grown that dealers are using the many assembled orders as a way to forecast buying or selling pressure.
With that advance peek at investors' intentions, dealers could trade to their advantage -- and against investors' interests -- before the market opens. For example, a dealer might see from overnight orders funneled to it from brokerage firms around the country that many buy orders for a particular stock are queued up in advance of the opening. Armed with knowledge of that demand, a dealer might buy shares at a lower price before the opening, only to sell them to customers at a higher price once the trading day opens and the collective demand begins to push up the price.
The proposed rules are outlined in a memo between Nasdaq and its
Quality of Markets Committee
, said senior vice president S. William Broka. But any change isn't likely until the end of the year at the earliest, he said. A subcommittee will study the issue before reporting back to the main group, he said, and a
Securities and Exchange Commission
rule change would be required to implement changes.
"We're in the very preliminary stages," he said. The Quality of Markets Committee is Nasdaq's top advisory committee on market structure issues, and is made up of big-name brokerages and large trading firms.
Some brokerage firms are using information about customer orders to trade before the opening, the memo says, then filling customer orders at prices higher than what they themselves paid prior to the opening. No firms were named.
An SEC spokeswoman declined comment. But if adopted, the rules would be squarely in line with the mantra of SEC Chairman Arthur Levitt, who in recent months has been pushing very publicly for "best execution" -- more openness and better handling of customer orders, especially those of small investors.
"The duty of best execution must be woven more fully into the fabric of our markets," Levitt said in a recent speech. "It must be at the very core of our promise of integrity to investors -- a promise that brokers will act in their customers' best interest when they route and execute orders. Best execution encompasses a number of factors, starting with the price of the execution and the opportunity for price improvement."
Not surprisingly, Vanguard's Sauter likes the potential new rules. "It's definitely a good thing," he said. "It's good for individual investors and anyone trading at the opening."
Stephen C. Richards, senior vice president of the
, an online trading firm popular with individual investors, also endorsed the proposals. "The next step (should) be to give any benefit that wholesalers get, by looking at the preopening queue, to the retail investor," he said. "That's a benefit the entire market community should enjoy."
Philip M. Aidikoff, a southern California attorney who represents individual investors, said the new rules would help lessen the inherent conflict of interest that dealers face with investors.
"It says you can't trade ahead of your customer," he said. "The customer must come first. Anything that reduces the conflict of interest is good for the market and good for investors."
The Nasdaq proposal has two specific parts. The first would require that a market maker holding both a customer's limit order -- that is, an order to buy or sell at a specific price -- and an in-house order for itself at the same price must fill the customer's order first. That's already required after the market opening, but the proposal would advance the beginning of the price-protection window by an hour to 8:30 a.m.
The second proposal would require market makers to give customers' market orders -- that is, orders to trade not at specific prices, but instead at whatever the prevailing price may be -- the benefit of any prices dealers obtained in preopening trading.