Nasdaq Stock Market

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NASDAQ STOCK MARKET

Often referred to as the pulse of the New Economy, the Nasdaq Stock Market, operated by the National Association of Securities Dealers (NASD), is divided into two separate markets: the Nasdaq National Market, comprised of over 4,000 of the largest and most heavily traded Nasdaq securities and featuring heavy financing, capitalization, and corporate governance standards for listed companies; and the Nasdaq SmallCap Market, which caters to smaller, emerging companies and maintains more relaxed listing requirements. The general course of stock movement is to graduate from the SmallCap Market to the National Market. Nasdaq's listings are comprised most notably of companies operating in various sectors of high technology, including Internet companies and others devoted to aspects of the Internet architecture.

Nasdaq began trading in 1971, ten years after the U.S. Securities and Exchange Commission (SEC) charged the NASD with implementing a solution to what the U.S. Congress called a fragmentation in the over-the-counter securities market. Only in the closing decade of the 20th century, however, did Nasdaq truly emerge as a major benchmark by which the U.S. economy was monitored. Between 1997 and 2000, Nasdaq brought 1,649 companies public, according to NASD. With the Internet producing profound changes in economic life and the high-tech sector in which Nasdaq specializes leading the dramatic U.S. economic growth, the Nasdaq Stock Market became one of the most-watched stock indexes, alongside that of the New York Stock Exchange and major benchmarks like the Standard & Poor's 500 Index and the Dow Jones Industrial Average. It was on Nasdaq more than the others, moreover, that the hotshots of the Internet age were listed and on which New Economy investors focused their attention.

Nasdaq, like the New York Stock Exchange, runs trades through market makers, middlemen who work on the trading floors—or, in Nasdaq's case, at computer terminals that receive instantaneous market information and on which they place buy and sell bids—and are generally backed by major securities firms such as Merrill Lynch and Goldman Sachs. When a stock finds no buyer, market makers use their own capital to purchase it. Later, they turn around and sell the stock at a higher price, and the spread between the buy and sell price constitutes their profit.

In addition to the market makers, Nasdaq allows electronic communications networks (ECNs) to implement electronic orders from their own diverse clientele. With these two brands of market participants, Nasdaq purports to increase the opportunities for its listed companies to have their stock bought and sold, thereby granting them greater access to capital and greater market visibility.

Prior to 1997, Nasdaq stocks were listed by quotations. In other words, stock prices listed on the screen represented the buy and sell bids of the market makers. Investors brought a class-action lawsuit against Nasdaq after a study reported that Nasdaq market makers were in the habit of stretching their profit margins by conspiring to keep the trading spreads-the difference between the buy and sell prices-artificially wide. Although collusion was never proven and the market makers settled out of court, the Securities and Exchange Commission (SEC) ordered Nasdaq to alter their order-handling rules so as to require market makers to list ECN quotes that beat the market maker's prices.

In spring 2001, Nasdaq switched its price listings to decimals, eliminating the fractions it had always employed. Immediately, and as expected, the spreads between the market makers' buy and sell bids diminished, particularly for the most heavily traded stocks. However, not all traders were eager to jump to decimalization; in the weeks before the proposed switch, the 7,700-member Security Traders Association (STA) petitioned the Securities and Exchange Commission (SEC) to postpone the deadline by at least three months, claiming that the tighter schedule would leave them unprepared and unduly upset their businesses.

LIFE IN THE DOT-COM ERA

The late-1990s tech-and Internet-fueled boom in the U.S. economy gave Nasdaq a prominence in the trading world that it hadn't before enjoyed. For years in the shadow of the older and more prestigious New York Stock Exchange, the close of the 20th century watched the Nasdaq emerge as the trendiest and most-watched market in financial circles. In the 16 months beginning January 1999, for instance, the 4,600 companies listed on Nasdaq watched their market capitalization skyrocket 150 percent to $6.6 trillion. Nasdaq rode the strength of such high-tech stalwarts as Microsoft, Intel, and Cisco, as well as the fleet of dotcom startups, to position itself as the market of the future and the financial hub of the New Economy, where the companies engineering economic growth were listed.

However, as a barometer of the dot-com economy, the Nasdaq was a bearer of bad news in the early 2000s. Following the dot-com crash of March 2000 and the subsequent nosedive of the Nasdaq—the market lost 40 percent of its value in 2000&mdahs;-a number of Internet companies were in danger of being delisted from Nasdaq due to stock prices that dipped below minimum requirements. Since the investment funds that were filtered through Nasdaq were so vital to most of the Internet companies, delistings could spell more doom and gloom for dot-coms. Other companies, such as the online brokerage E*Trade Group Inc., lost confidence in Nasdaq and defected to the rival New York Stock Exchange, citing the limits of company growth in the Nasdaq field as well as the excessive degree of volatility found on Nasdaq.

Compared with the New York Stock Exchange, Nasdaq was especially volatile, marked by rapid fluctuations, even in its glory days in the late 1990s and early 2000s, largely due to the dearth of dot-com and other high-tech stocks traded on that system. Since these sectors were the primary engines behind the dramatic growth in the U.S. economy in the late 1990s, Nasdaq was marked by heavy trading from investors hoping to profit from the strong economy, but buying and selling were rapid and often erratic as market information shifted quickly.

RIVALRY WITH ECNS AND SUPERMONTAGE

In the late 1990s, Nasdaq was challenged by a new breed of trading entities known as electronic communication networks (ECNs). ECNs spearheaded the public's zest for electronic trading, and their astonishing success led many Wall Street analysts to believe that they were the wave of the stock market's future. ECNs claimed to democratize investing by making it cheaper and bringing it directly to the public at large, reducing the reliance on large brokerage firms. While the rapid turn-around of the dot-com economy in the early 2000s also served to sour the revolutionary prospects for many ECNs—to the point that many, including Island ECN, were turning into exchanges themselves—there was little doubt that these upstarts greatly accelerated innovation and modernization among the major exchanges, particularly Nasdaq. For instance, ECNs led the way in opening after-hours trading and listing share prices in the more accurate (and less fraud-prone) decimals, rather than in fractions. Having adopted much of the ECN-driven innovation, and with a vastly greater economy of scale, Nasdaq was expected to make it much more difficult for its one-time rivals to compete.

For instance, one practice for which ECNs roundly criticized Nasdaq was its refusal to offer customers information such as comparative pricing for individual stocks, which would then allow customers to get the best deal. In the early 2000s, however, that changed with the introduction of Nasdaq's SuperMontage, a quote aggregation and execution system. SuperMontage was a serious blow to the ECN competition, since it offered most of the same functions that distinguished ECNs. Nasdaq spent the early 2000s pushing SuperMontage through the SEC approval stages. Because of its similarities to the ECN model, SuperMontage raised the ire of ECNs, who claimed that the system would effectively amount to an ECN that enjoyed government-mandated liquidity, putting ECNs at a hopeless disadvantage, and worse, turning their regulator into a competitor.

FOREIGN EXPANSION

The NASD announced in 1999 its intentions to spend generously on Internet technology for the purposes of staving off competition from ECNs and, simultaneously, to expand globally. Its ultimate goal was a globally integrated securities market under its purview. Nasdaq launched its London-based European exchange in late 2000. Around the same time, Nasdaq established its own Japanese board in conjunction with the Japanese Internet investment company Softbank, linking Japanese investors seamlessly to Nasdaq's U.S. and European markets. This added to Nasdaq's existing Internet Web service in partnership with the Stock Exchange of Hong Kong, which offers information service on various markets to investors across the globe. Nasdaq won praise from analysts for its success in integrating various trading cultures into its own system.