Double Blow for the Big Board

For most investors, the big stock market news last week was that the Dow Jones industrial average hit a 22-month high of 920. To the Wall Street establishment, the movements of the average were of only secondary interest. Their attention was riveted on two innovations that moved the New York Stock Exchange into a new era of intensified competition that could reshape the nation's securities business.

At minimum, these changes make the N.Y.S.E. a less secure and lucrative place for a broker. For 179 years, the Big Board has had two major attractions: it offered a broker a commission structure that competitors could not undercut and it was just about the only place where a broker could trade the nation's best-known and most popular stocks. Last week both of those keystones began to crumble, raising the question: Who really needs the exchange?

The first change requires free-market pricing--a principle of capitalist economics that the exchange, which regards itself as the citadel of U.S. capitalism, had been reluctant to accept. The Big Board had insisted that member brokers abide by a fixed minimum commission schedule. Last week it bowed to an order from the Securities and Exchange Commission and abolished fixed commissions on the portion of any trade in excess of $500,000. Such trades account for about 5% of N.Y.S.E. members' commissions but are clustered among the major houses, including Salomon Bros., Oppenheimer and Goldman, Sachs.

Brokers lost no time cutting their fees to win the business of rich investing institutions--mutual funds, pension funds, trusts, insurance companies. One minute after trading began under the new rules, a $3,958,875 block of Uni-royal stock changed hands at a commission lower than would have been charged the week before. How much lower is a secret, but commissions on other giant trades dropped anywhere from 10% to 80%.

The SEC has made clear its determination to force the New York and American stock exchanges to extend negotiated commissions to all trades above $100,000. It is being prodded by the Justice Department, which has a voice in the matter because of Supreme Court decisions that hold the exchange is not exempt from antitrust laws. Commission cuts are likely to become deeper as well as wider. Some small brokerages have announced that on big-block trades they will negotiate commissions as low as a penny a share v. 23-c- for an average-priced stock under the old fixed-rate structure.

As a result, the income of exchange-member brokerages will be so drastically reduced that some may not be able to survive in their present form. SEC Commissioner James Needham thinks that many houses will diversify "into such things as money management, selling bonds, financial planning for their customers, even selling insurance." Some brokers foresee an eventual split of the exchanges into two markets--in effect if not in formal organization. In the more important market, institutional investors would trade stocks in huge blocks at low, negotiated commissions. In the less significant market, a declining number of individual investors would trade in small lots at fixed, higher commissions.

Computerized Market. Even that vision assumes that the exchange trading floor will remain the nation's central marketplace for stocks. But the second of last week's changes calls that idea into serious question. The NASDAQ* computer network, which flashes price quotations for more than 2,500 over-the-counter stocks on desktop consoles in brokerage offices throughout the country, began carrying quotes for 32 Big Board and American Stock Exchange issues as well. Among them: General Motors, A.T. & T., Jersey Standard, U.S. Steel. A trader with a Big Board ticker and a NASDAQ console can thus continuously compare the prices at which these stocks are selling on the exchange with competing prices offered by brokers who are not exchange members.

On the exchange, all orders for any specific stock go to a single "specialist" who is assigned to make the market in that issue. His price quote is the only one available. But in the NASDAQ system all brokers willing to make a market in a stock feed price quotations by coded message into the computer network. A broker who gets an order presses a combination of computer keys, and the desktop console shows him all the prices being offered. He selects the most favorable price for his client and makes the trade by telephone.

Last week the NASDAQ consoles showed several spreads of $1 a share or more between exchange and off-board prices. For example, when Northwest Bancorp. was trading on the exchange at 38 3/4, outside brokers were offering to sell it at 37 3/4.

Exchange officials have long contended that their system is necessary to avoid the chaos that would result if different brokers were trading the same stock at widely different prices. NASDAQ proponents retort that this idea is a relic of precomputer days. Says Donald Weeden, head of a non-exchange brokerage firm that bears his name: "The central market is a communications concept, not a piece of real estate at Broad and Wall Street. With today's computer possibilities, we can and should have a central market stretching from London to Tokyo, made up of competing market makers with access to all inquiries from all buyers and sellers."

American Zaibatsu. Whether the exchange can survive against NASDAQ competition may depend on its ability to preserve Rule 394(b) of its constitution. That rule provides that a Big Board member can trade outside the exchange only with the permission of an N.Y.S.E. official and sets up a cumbersome process for getting the permission. Its effect is to force members to make nearly all their trades in listed stocks on the exchange floor. So long as the rule is retained, the potential of NASDAQ can be exploited only by so-called "third-market" dealers--those brokers, like Weeden, who are not exchange members, yet trade in Big Board stocks. Rule 394(b) may soon come under antitrust attack. If it is overturned, there would be little incentive for anyone to keep an exchange seat, a fact that has been illustrated with brutal clarity by the price of Big Board memberships. One sold last week for $195,000, down from a high of $515,000 at the end of 1969.

If Big Board members start trading heavily through NASDAQ, "Wall Street" would then be well on the way to becoming a nickname for an international computer network. Such a market would have both good and bad features. Because the costs of big trading would be lower, the mutual funds might find themselves under Government pressure to reduce the fees that they charge customers. On the other hand, the market would be so fast-moving that hardly anybody but professionals could keep up with it. That would give institutional investors an even greater advantage over individuals than they have in the present market. At the theoretical extreme, a handful of mutual-fund managers could become an American version of the Japanese zaibatsu, controlling much of the economy through their institutions' stock holdings. The one certainty would be that trading would hardly resemble the operation that brokers and investors have become accustomed to think of as a stock market.

*For National Association of Securities Dealers Automated Quotation system.

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