This letter is in response to the NASD's proposal to radically change the nascent SuperSoes trading system as of November 1st of this year. The NASD wants to do away with the requirement for NASDAQ market makers to display 1,000 shares when holding reserve size and to refresh increment changes. I consider this idea flawed in its reasoning and dangerous in its intent. It promises significant expansion of institutional privileges at the expense of market efficiency and the small investor.
It is clear at face value that the proposed rule change will lead to reduced transparency in the marketplace. A market maker's quote for as little as 100 shares may become routinely perceived as something intrinsically more important. In the hands of a trader intent on manipulation, it may become a dangerous tool. A small quote may be used to create a false momentum; a quote that fails to refresh increment changes may become a means to suppress a genuine move. There is a rich history of rogue practices on the part of market makers. The rule now proposed increases the vulnerability of the marketplace to such practices.
Inarguably, the basic market quote consists of price and size. The proposal at hand will effectively allow market makers to display an arbitrary size, rendering that part of the quote virtually meaningless. How could this proposal not reduce market efficiency?
Being a market maker by definition entails certain responsibilities. Providing transparency and liquidity is key. In return, the status provides privileges, such as the ability to sell short on a downtick. The rule change proposed not only further reduces market makers' responsibility to enhance transparency and liquidity; it enables, if not encourages, market maker behavior that undermines these key ingredients of an efficient and fair marketplace. The ultimate result is a growing power gap between institutional traders and the small investor. The latter, along with the quality of the marketplace, is the ultimate loser.
One might argue in favor of the proposal on the grounds that it would grant market makers the rights that are already enjoyed by electronic communication networks (ECN's). This reasoning is flawed for two reasons. First, the market maker quote should be held to a higher standard than an ECN quote, which all market makers can use, anyway. And second, the effects on the marketplace of allowing ECN's to display quotes that are more or less arbitrary, are dubious. It seems logical that holding ECN's to the reasonable standard now applied to market makers may very well lead to more transparent and fair markets. By contrast, the NASD proposal seeks to enact the lowest common denominator.
This rule change aims at an unjustified erosion of market maker responsibilities while opening a Pandora's box in the realm of market manipulation. The ultimate result is a marketplace increasingly unfriendly to the small investor. I respectfully request that you address these concerns in considering the proposal.