Inside Nasdaq

The Nasdaq stock market is known worldwide as the leading market for trading tech stocks. But the New York-based electronic stock market is also emerging as a top-notch market for an array of other services and listings. Only 30 percent of Nasdaq’s issuers are information technology companies, while 20 percent are financials and 18 percent are healthcare companies. Its issuers include such household names as the airline JetBlue and coffee company Starbucks. 

‘The idea that Nasdaq is a technology-driven market, in terms of having a large number of tech stocks on it, is a common perception,’ says Adena Friedman, executive vice president of data products and head of strategy at the exchange. ‘We certainly don’t want to discourage that perception, but Nasdaq has listings from every industry in America.’ 

In fact, Nasdaq currently hosts the largest number of listed companies in the US and executes the most trades per day. ‘Trading electronically allows Nasdaq to run faster and more efficiently and allows for more transparent trades,’ explains Friedman. The major stock markets of every other country in the world, excluding Argentina and the US, home of the floor-based NYSE, now trade electronically, and from an economic and corporate governance standpoint this may be the best way to go. 

Market structure

The idea for Nasdaq took root in 1961 when the SEC conducted a Congress-authorized study on fragmentation in the over-the-counter market. The SEC’s findings led it to propose setting up an automated system, which it charged the National Association of Securities Dealers (NASD) with developing and implementing. On February 8, 1971 the system – the National Association of Securities Dealers Automated Quotation (Nasdaq) – began trading. By the end of 1972 there were 3,454 securities in Nasdaq’s system, with an annual total share volume of 2.2 bn. 

‘In the late 1980s we added real-time trade reporting, and believe we have surpassed our competition in terms of the level of efficiency and the depth of market and services we provide,’ Friedman says. Nasdaq’s average daily share volume in 1990 was 131.9 mn compared with 1.89 bn in 2004 (through the end of June), an increase of 1,333 percent. 

A fully computerized market, Nasdaq’s ‘open architecture’ philosophy allows it to link all liquidity providers together in a given stock, to compete efficiently and on an equal footing. ‘What we receive is what we send out to the investors, so they understand exactly what is going on and have the same amount of information available to them as we do,’ Friedman explains. In a closed system, such as the floor of the NYSE, that doesn’t happen, she notes.
 
Nasdaq participants include about 250 market makers who commit capital and buy inventory to sell to investors. Each Nasdaq stock has an average of 17 market makers who are required at all times to post their bid and ask prices into the Nasdaq network, where they can be viewed and accessed by all participants. 

Nasdaq also connects alternative trading systems/electronic communication networks, which electronically match submitted buy and sell orders. Unlike market makers, who are required to buy and sell at all times, alternative trading systems/electronic communications networks execute trades only when matching buy and sell orders are submitted to them. 

Regulatory changes

‘We went through a period in 2002 and 2003 in which we made more changes than at any other time; and we will continue to make changes as the capital markets evolve, new corporate structures are tested, and new governance questions arise,’ says Edward Knight, Nasdaq’s executive vice president and general counsel. 

In 2002, with the advent of the Sarbanes-Oxley legislation, both Nasdaq and the NYSE developed their own proposals for corporate governance overhauls. These were submitted to the SEC, and approved in November 2003. 

‘It was a fairly complex process that played out over many months, but we think we have struck the right balance in terms of writing rules with real public policy benefits, without limiting the ability of companies to take calculated and thoughtful risks with their shareholder equity,’ Knight says.
 
Nasdaq also has a detailed web site (www.nasdaq.com), which offers an abundance of news, information and services for investors, existing issuers and companies looking to list. Topics include corporate governance regulations, listing fees and financial requirements. The web site lists hundreds of frequently asked questions (FAQs), too, offering interpretations of rules and regulations, and providing listing forms and procedures. 

For example, the site notes that a national market issuer is required to have at least $15 mn in shareholder equity if it also has $1 mn in income from continuing operations, or $30 mn in shareholder equity if it does not. 

The majority of the board of a Nasdaq- listed company must comprise independent directors who must meet regularly in executive sessions, separate from management and non-independent directors. 

Continuing to adapt

The Nasdaq system has two tiers: one for national market securities and one for small caps, offering different listing requirements and different levels of service for each type. ‘We believe the ‘one-size-fits-all’ approach is not appropriate; instead we structure our rules to preserve flexibility, particularly for smaller issuers, while assuring accountability,’ says Michael Emen, senior vice president of Nasdaq listing qualifications. The exchange also makes listing qualification staff available to companies that would like
over-the-phone counseling. 

An electronically run stock market, Nasdaq has always relied on technology for best execution and as a way to track issuers’ corporate governance compliance. In the mid-1990s it developed the issuer support system, which inputs data about issuers from both SEC filings and outside sources. The system devises a complete issuer history, which helps to ensure all corporate governance, financial and public interest standards are being maintained.
‘It is the most sophisticated system there is right now for tracking our listing standards and tracking our issuers’ maintenance against those standards,’ says Friedman. If a company falls out of compliance the system alerts the listing qualifications department and the issuer either has to regain compliance or be de-listed. The issuer can also request a hearing before a Nasdaq hearings panel, which in turn is reviewed by the listing hearing and review council, an independent advisory body. 

Using electronic technology has helped Nasdaq provide trading efficiency, transparency and depth of market on a real-time basis. According to Market Information Services, a provider of best execution analysis, whose figures were included in the SEC-mandated market quality report released in April 2004, the time to complete the trade of an S&P 500 stock on Nasdaq was 6.2 seconds compared with 17 seconds at the NYSE. Additionally, the average effective spreads were 1.10 cents on Nasdaq compared with 1.86 cents on NYSE. These narrower spreads reduce transaction costs. 

Nonetheless, there are times when an auction-type trading may be preferable for certain investors. On April 12, 2004, Nasdaq launched its ‘closing cross’ electronic auction system, which occurs right before the trading day’s close from 3:50 pm to 4 pm to allow for order imbalance information to be disseminated. 

‘We are trying to leverage the fact that there are specific points during the day where an auction is useful and can be quite helpful to gauge supply and demand in the market,’ Friedman notes. In the fall the exchange will launch the electronic Nasdaq opening cross auction, which will run from 9.28 am to 9.30 am. 

This March Nasdaq also rolled out its new high-capacity single trading platform, the Nasdaq market center, which serves Nasdaq, NYSE and Amex securities, including exchange traded funds (EFTs). The trading engine incorporates all of Nasdaq’s current trading systems onto one system that has full capacity to trade all 6,679 US-listed securities, even in the event of a crisis. 

‘Our ability to trade NYSE, Amex and Nasdaq securities on one trading system means customers can enter orders, quotes and trade reports all on a single platform, creating increased efficiencies for market participants,’ states Bob Greifeld, Nasdaq’s president and CEO. 

Role of the secretary

In light of all these changes, corporate secretaries at listed companies are being given additional responsibilities and being tested in new ways. ‘What has happened in the aftermath of all the recent changes in corporate governance is that the role of the corporate secretary has become more visible and people have a renewed respect for what corporate secretaries do,’ says Knight. But while much progress has been made in terms of redefining governance rules and clearing up ambiguities, interpretive questions still remain, he notes. 

Efforts to clarify these questions and make procedures as efficient and fair as possible are underway. ‘We have thrown a lot at the corporate community in terms of new rules. Now we need to take a step back and let those rules work – and live under them for a while before we start amending them,’ Knight concludes.