Herzog Heine Geduld
Established 1926. Member of the New York Stock Exchange.
RE: File No. SR-NASD-98-17
Dear Mr. Katz:
In past letters to the Commission, we have expressed our strong opposition to Nasdaq's proposal to establish a central limit order book, the so-called Integrated order Delivery and Execution System. We are disappointed that Nasdaq has suggested that its proposed agency quotation rule and the accompanying proposal to permit Nasdaq market makers to charge fees to persons who access their quotes is an interim measure pending approval of its limit order book proposal. We support the proposed agency quotation rule, together with the accompanying fee proposal, and believe that these rules should be adopted on a permanent basis. We continue to believe that it is contrary to the public interest for Nasdaq to establish a central limit order book in competition with the business of its members and further oppose Nasdaq's proposal to operate the central limit order book as a pilot program.
Herzog Heine Geduld has been a market maker in securities for more than 70 years, and we were one of the original participants in the first Nasdaq system. It has been our privilege to participate first-hand in the development of the Nasdaq marketplace, which has experienced rapid, continual and dramatic growth from its inception.
We believe that the growth of the Nasdaq marketplace is attributable to the excellent service this market and its professional participants provide to the investing public. Strong and enlightened regulation has undoubtedly played an important role in ensuring that investors receive fair treatment from all market participants. This regulation has been most effective, however, when it has worked to enhance competition among market professionals.
Market makers have spent millions on technological improvements in an effort to provide better service to retain and attract customers. They have pioneered innovative order execution techniques, discovered new ways to distribute market information and engineered expensive and complex interfaces to a multitude of trading systems. None of this innovation was inspired by regulatory requirements. Instead, market makers responded to the forces of competition and their desire to maintain viable businesses, and this competition continues unabated to the present time.
We oppose the central limit order book proposal because we believe that it will significantly reduce competition among Nasdaq's market makers. It is not necessary for a governmental organization to prohibit competition in a marketplace to create a monopoly. If groceries could be obtained at a government-owned and operated supermarket, other grocery stores would find it difficult to compete. Regulators employed by government agencies would be inclined to help the government operation succeed by leaning ever so slightly on its privately-owned competitors. Purchasers of groceries would avoid stores that competed with the government for fear of reprisal, and pricing would have to be adjusted in the privately-owned stores to overcome these concerns. Finally, government subsidies would keep the enterprise in business, despite mistakes that would drive private enterprises into insolvency. In a business where a few pennies one way or the other makes a difference, privately-owned stores would find themselves at a significant disadvantage, and capital would flow to other more profitable enterprises.
As competition dries up, service deteriorates. Guaranteed a steady supply of customers, the government-run enterprise feels little pressure to provide service improvements, except from politicians who lack the expertise and information necessary to properly assess the needs of the persons served by the enterprise. This experience has been repeated many times in the twentieth century in any number of markets. In spite of the best efforts of intelligent and idealistic individuals, government-owned and operated markets have always resulted in undesirable and often disastrous consequences.
Orders that Nasdaq would accept into its "voluntary" central limit order book are orders that Herzog Heine Geduld competes for today. Currently, our customers are required by regulation to make certain that orders sent to us receive best execution. In a world where Nasdaq maintained a central limit order book, customers would believe that orders sent to us might be subject to regulatory scrutiny, while orders sent to the central limit order book would be safe. Securities regulators would be inclined to help the government-owned and operated system succeed. In a variety of subtle ways, they would make it disadvantageous for order-entry firms to use competing private systems. The central limit order book would be supported by fees assessed on Nasdaq's members, insulating it from failure and the discipline of market forces. It would be difficult, if not impossible, to overcome these competitive advantages. The use of other competitive limit order facilities, including our own facilities, would diminish, and no sensible businessperson would invest in the development of new systems. Without competition, service in the Nasdaq marketplace would deteriorate.
We strongly believe that competition results in superior pricing and improves the efficiency and quality of any market and particularly the Nasdaq market. Nasdaq's proposed central limit order book will destroy competition and eliminate incentives to create useful innovations. A pilot program is neither required nor useful to demonstrate this result, which history tells us becomes more evident over time. We urge the Commission to reject this harmful proposal.
We very much appreciate this opportunity to explain the reasons for our strong opposition to Nasdaq's Proposed Central Limit Order Book. Please call me at (201) 418-4100 if you have any questions.