NASDAQ Spread Fixing: The Price of Keeping Spreads Wide

The approximately $1.027 billion NASDAQ market makers antitrust settlement resolved allegations that dealers coordinated bid-ask spreads by avoiding quotes that would have made trading cheaper. The court approved the private settlements on November 9, 1998, with anticipated fund interest included in the total.

The government’s case targeted a quoting convention that allegedly suppressed price competition. For someone on a trading desk, the revealing detail may be what happened when a dealer tried to offer a better price: who objected, what they said and whether the quote changed afterward.

How the Quoting Convention Kept Spreads Wide

NASDAQ spread fixing concerned the distance between buying and selling prices, and the increments dealers used to change them. In its 1996 explanation of the civil case, the Justice Department described an alleged agreement that discouraged dealers from using narrower quote increments.

A market maker continuously quoted a bid, the price at which it would buy a stock, and an ask, the price at which it would sell. The difference was that dealer’s spread. NASDAQ displayed competing dealers’ quotes together. The highest bid and lowest ask across those dealers formed the inside quotes, and the gap between them was the inside spread.

A dealer could keep a wide gap between its own buying and selling prices while another dealer improved the best price available to customers. The alleged convention constrained how that improvement happened across the market.

For stocks priced at $10 or more, the permitted minimum quote increment was one eighth of a point. Under the alleged convention, a dealer whose own spread was three quarters of a point or wider used even-eighth quotes, moving in quarter-point increments. That kept the inside spread at a quarter point or wider in the affected stocks.

Odd-eighth quotes were allowed under the convention only when the dealer narrowed its own spread below that threshold. The Justice Department explained why this mattered commercially: a narrower dealer spread increased the chance of being called on to buy when the trader wanted to sell, or to sell when the trader wanted to buy. Offering a better quote came with an additional inventory risk under the convention.

The customer felt the effect at execution. Retail market orders historically traded at the inside bid or ask. Large institutions could sometimes negotiate better prices, but the inside spread influenced those negotiations too. The Justice Department alleged that keeping spreads wide raised investors’ trading costs: they paid more to buy and received less when they sold.

The Pressure Behind the Price Pattern

The government’s proposed order addressed both coordinated quotes and pressure on dealers that narrowed spreads. Its terms show why an account of the conversations between competing desks matters alongside the trading data.

The proposal would prohibit agreements fixing quotes, spreads and quote increments. It would also prohibit harassment or intimidation of another market maker for cutting a spread, and refusals or threats to refuse to trade with that dealer at published quotes and quantities. The target was a market in which a dealer’s effort to compete could prompt competitors to withhold business.

The Justice Department also sought recording and monitoring of trader conversations, with potentially violating conversations reported to the department. This was part of the proposed civil settlement’s approach to stopping a recurrence.

The economics and the pressure belong in the same account. A quote history shows which prices disappeared. Someone who worked on the desk may know why a trader stopped offering them, who insisted on the convention and how the desk responded when a rival broke it.

From Academic Detection to Trading-Desk Evidence

An academic study drew attention to the missing odd-eighth quotes before the government’s case. According to the Justice Department’s account, its investigation began in the summer of 1994, shortly after publicity about research suggesting tacit coordination among NASDAQ dealers. Private class actions followed the study’s publicity as well.

The investigation then moved into the business behind the pattern. The department examined documents and written answers, questioned current and former employees, interviewed traders and investors, and reviewed quote changes alongside actual trades. It also reviewed testimony from a concurrent Securities and Exchange Commission inquiry.

Investigators listened to approximately 4500 hours of trader telephone calls. The firms had recorded those calls in the ordinary course of business. The tapes put conversations between dealers beside the prices those dealers displayed.

That combination gives an insider’s account its value. A trading record can show when a quote changed. A conversation can explain whether a competing desk demanded the change. Testimony from someone who understood the desk’s practices can connect the two.

In a trading desk investigation, the person who understands the trading decisions can supply the explanation behind a pattern that outsiders can see.

The Government Order and the Private Fund Had Different Jobs

The government case sought changes to dealer conduct. The private cases sought compensation for investors who allegedly paid too much to trade. Academic detection helped bring attention to the practice.

The distinction also explains why market design appeared in the government’s discussion. The department described a separate SEC rule requiring market makers to execute incoming customer limit orders or display them when they improved the dealer’s quote. That addressed how a better customer price reached the market. The proposed antitrust order addressed agreements and pressure among dealers.

Both concerned price competition, but they operated at different points in the trade. One opened the displayed quote to a customer’s better order. The other sought to stop rival dealers from agreeing how they would quote.

Antitrust Fund Interest, Treasury Securities and Noncash Components

The NASDAQ settlement fund combined cash, Treasury securities valued at maturity and deferred payments. The private resolution included separate dealer settlements and a group agreement covering firms including Goldman Sachs, Merrill Lynch and Morgan Stanley.

That group agreement accounted for $909,867,925 in obligations. Specified deferred portions bore interest. The fund’s anticipated interest used an expected distribution date in 1999.

The court awarded 14% of the aggregate, expressly $143,780,000, in fees. That award came from the fund before investor distributions. The figure was payment for the work of pursuing the private case, not a whistleblower reward.

Another Dealer Market, Another Way to Protect the Spread

A later credit default swaps complaint alleged that dealers protected their position by threatening brokers that let outsiders participate. It described the pressure in commercial terms:

The complaint alleged that dealers used their business with interdealer brokers to restrict access to trading. The NASDAQ proposal addressed pressure against dealers that cut spreads. The common point is the pressure on any firm that challenged the arrangement.

For an insider, those decisions can be easier to recognize than the overall cost to customers. The instruction to withdraw business, the objection to a better quote or the decision to exclude a trading participant gives the price pattern a human explanation.

How Much of a Settlement Does a Whistleblower Get?

A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. NASDAQ’s private settlement was compensation for investors alleging trading losses.

The Antitrust Whistleblower Rewards Program has its own eligibility rules. We work through the connection between your information, the market conduct and the applicable reward program with you.

When You Know Why the Quote Changed

If market makers agreed how wide to keep a spread, tell our whistleblower experts what you saw at the quote or trading desk.