Mr. MARKET Nasdaq's master promoter trades on his vision of future

THE BALTIMORE SUN

Joe Hardiman has a clear vision of the world's stock markets -- and it doesn't include chaotic exchange floors where traders shout their orders.

The future, he says, is the Washington-based Nasdaq stock market. Eventually, all but the dinosaurs of the last industrial revolution will list their stocks on that system, Mr. Hardiman predicts, to benefit from its computerized services and thoroughly modern image.

He has honed that message in countless speeches. Now, armed with a multimillion-dollar ad budget and slick television commercials, Mr. Hardiman has become Nasdaq's master promoter.

And his vision may just be right.

Under the stewardship of the 56-year-old Baltimorean, Nasdaq has grown from a relatively obscure trading system of small-company stocks into one of the world's largest stock markets. Today, it trails only the New York Stock Exchange in dollar trading volume, and with high-powered listings such as Microsoft Corp., Nasdaq poses the first serious challenge to the venerable New York exchange.

Throughout the transition, Mr. Hardiman has overseen Nasdaq's push to regulate its market of 4,300 stocks and has helped publicize every success.

"He's . . . worked hard to tell not only investors but the whole world about the Nasdaq system. He's realized the potential of the Nasdaq system," said Hans Stoll, director of the Financial Markets Research Center at Vanderbilt University.

But as Mr. Hardiman completes the remaining years of his tenure, Nasdaq is attracting criticism, too.

Critics charge that Nasdaq's computerized trading system hurts investors because it gives preference to the Wall Street firms that buy and sell its stocks. For small investors, it's much harder to obtain the best price on Nasdaq than on the exchanges, and the winners in Nasdaq trades often are the companies that act as intermediaries on the system, critics say.

The debate over Nasdaq's future has intensified recently, as the federal government wraps up a study that could recommend far-reaching changes in regulating U.S. stock markets. If the study comes down on Nasdaq's side, the stock exchanges could be threatened. But if Nasdaq's way of selling stocks is curbed for its alleged biases, Nasdaq's challenge -- and Mr. Hardiman's ambitious plans -- could be thwarted.

Mr. Hardiman seems more a blue-chip lawyer than stock market revolutionary. But his quiet, self-assured manner hides a tougher edge.

At the University of Maryland Foundation, for example, Mr. Hardiman heads the audit committee and grills staff members annually on the $100 million organization's finances. "He has a very dry sense of humor, and while I appreciate his humor, after he gets through with us, I want to take a week's vacation. He's tough," the foundation president, John Martin, said.

The former securities lawyer had a similar reputation at Baltimore-based Alex. Brown & Sons Inc., where he rose to chief operating officer and earned respect as a no-nonsense administrator.

"He ran a very tight ship during his 12 years with Alex. Brown. He was firm, fair and serious," said J. Carter Beese, an SEC commissioner and former Alex. Brown partner.

That toughness was tested soon after Mr. Hardiman left the firm to lead the National Association of Security Dealers, parent of the Nasdaq market. Just weeks after he arrived in 1987, the stock market crashed, and Nasdaq suffered a public relations disaster.

Customers claimed that Nasdaq market makers -- the intermediaries who handle trades -- refused to fill orders as market values plummeted on Oct. 19. That left many investors holding devalued stocks that they had been trying to sell.

That criticism was a strong challenge to Nasdaq, a system that had gone from trading 2 billion shares in 1971 to 37.9 billion in 1987. Unlike stock exchanges, with their busy trading floors and specialists who execute stock orders, Nasdaq has no trading floor, just a computer network that shows what market makers are offering for a stock. Investors buy or sell from the market makers, not each other.

Mr. Hardiman took steps, however, to restore some of that lost confidence by automating the execution of small trades and by forcing market makers to sell or buy up to 1,000 shares of stocks at the listed price. The new rules were designed to help guarantee that small investors would not be trampled by institutional investors and that market makers would give priority to clients rather than personal stock accounts.

Such moves shored up Nasdaq's credibility, just as the markets boomed in the late 1980s. Nasdaq continued to grow in volume -- $891 billion was traded last year, a dollar volume second only to the New York Stock Exchange's $1.8 trillion.

Meanwhile, Nasdaq has become the home of many big stocks. It now boasts more than 100 members with a market capitalization of over $1 billion each, including companies such as Microsoft, Intel Corp. and Apple Computer Inc. These huge companies once would have moved to the American Stock Exchange and, later, to the New York exchange.

Give credit to Mr. Hardiman's diligence in wooing high-tech companies. "They have bent over backwards to support us," said Gretchen Lium, an investor relations specialist at computer chip maker Intel.

Intel, for example, receives sophisticated, computer-generated analyses of trading in its stock -- information that is not available at the exchanges, Ms. Lium says. Intel can call on these reports to satisfy investor questions about trading patterns of its stock.

Such innovations, combined with ads touting Intel and other high-tech companies, allow Mr. Hardiman to portray Nasdaq as a sprightly, future-oriented market. In a jab at the 202-year-old New York exchange, Nasdaq boasts that it's the "stock market for the next 200 years."

"There is a perception that they foster with their advertising campaigns that the Nasdaq is more high-tech," said Larry Glosten, visiting economist at the New York Stock Exchange last year and a professor at Columbia Business School. "It may not entirely be true, but it has been effective."

Are small investors hurt?

What the marketing ignores, critics argue, is that Nasdaq's system hurts small investors. They charge that the system does not always allow buyers and sellers to get the best possible price for a stock.

To understand those charges, consider how a trade can take place using Nasdaq.

Mr. Jones tells his broker to buy stock in XYZ Corp. for $30.125 a share. The broker looks at the Nasdaq quote system and notes that the stock's market makers are offering to sell for $30.25 and buy for $30. Mr. Jones has three choices: Cancel the purchase, pay $30.25 or wait and hope the price falls to $30.125.

On a stock exchange, by contrast, the Jones offer of $30.125 would replace the $30 bid and become the highest listed bid. The seller could then decide if he wanted to sell at $30.125. On Nasdaq, market makers have no obligation to consider the $30.125 bid, so the quotes could remain $30.25 and $30.

Although market makers can compete among themselves -- so that, in theory one would post the $30.125 bid to win business -- there's no guarantee this will happen, especially for small stocks that have few market makers.

Intermediaries profit

Another problem: Market makers can buy discounted stocks and share the profits with each other instead of with the customer.

Forbidden by the exchanges, the practice known as "payment for order flow" is not illegal on the Nasdaq, although it has acknowledged that a problem exists. It works like this: Say Mr. Jones still has his offer to buy stock in XYZ Corp. at $30.125. A market maker may flash the price over an internal quote system -- which buyers and sellers can't see.

Meanwhile, the seller who is asking $30.25 grows frustrated, thinking that no one will buy his stock at his asking price. He sells to a market maker for $30, not realizing that Mr. Jones is willing to pay $30.125. The market maker who now has the $30 stock decides to take up the Jones offer, making 12.5 cents on each share. As thanks, he gives the market maker who buys the stock a couple of cents per share and pockets the rest -- paying for the order flow.

In this case, Mr. Jones made out fine -- he got his stock for $30.125 -- and both market makers made a profit. The loser: the person whose shares were sold for $30 instead of $30.125.

That practice has allowed some brokerages to offer no-commission trading of Nasdaq stocks -- they don't charge a commission because a profit is built into the system.

On the exchanges, by contrast, commissions are charged to pay the specialists who execute orders in a first-come first-serve order. Although the stock exchanges have similar problems, and illegal acts are committed, specialists are prohibited from buying or selling on their own accounts ahead of their customers.

Studies of such issues are highly partisan and seem to reflect the patron paying for the work, but the bottom line for investors is that buying Nasdaq stocks can be more expensive. And evidence suggests that more buyers are bypassing Nasdaq.

For example, Instinet, a subsidiary of Reuters America Inc., has seen its sales increase 60 percent a year over the past four years, to $95 million last year. Institutional investors and brokers use Instinet to trade directly with each other and bypass Nasdaq's market makers.

Mr. Hardiman concedes that prices may be slightly higher on Nasdaq, but argues that the added expense is acceptable because Nasdaq stocks have outperformed those sold on the exchanges. "If your transaction costs are a little higher but your returns are much higher, then your transaction costs become infinitely small in proportion to the total return."

Critics, however, say that Mr. Hardiman and Nasdaq should focus on building an efficient mechanism to execute stock trades.

"For him to take credit for how Microsoft does is ridiculous. It would be a great company even if it were on the NYSE," said Harvey Houtkin, who heads All-Tech Investment Group, an arbitrage firm that is at odds with Nasdaq over its small-stock trading system.

"The thing is, Nasdaq does not represent customers," he said. "It represents dealers. Who are the dealers? The big names on Wall Street."

A crucial test

A crucial test of Mr. Hardiman's stewardship could come later this year, when the Securities and Exchange Commission releases it long-awaited "Market 2000" study. Observers say the study could be as crucial to the future of the markets as an early-1970s SEC study that resulted in Nasdaq's creation.

The upcoming study, for example, could make it easier for companies trading on the exchanges to have their stocks traded on Nasdaq as well. With Nasdaq market makers able to work without commission and to pay for order flow, it would be increasingly hard for the exchanges, especially the small, regional exchanges to survive.

"I think you could see the death of regional exchanges. It could be the end of Amex [American Stock Exchange], Chicago and Boston if Nasdaq gets the laws changed as it wants," said Cari Austin, co-chair of the National Specialists Association.

That prophecy doesn't bother Mr. Hardiman, who says that declining volume traded on the Amex shows that small exchanges are already smarting.

The Market 2000 report and the federal laws that it is likely to foster could cap Mr. Hardiman's career at Nasdaq. He has finished his sixth year at the helm and expects to stay a few more, but no more than 10 years total.

But he's positioning Nasdaq to prosper well into the future. He's already begun working in Eastern European to develop Nasdaq-style trading. Ultimately, he predicts, the world's stock trading will be connected by screen-based systems -- Nasdaqs uniting the world.

"I think eventually you will see all the markets of the world linked together through telecommunications networks," Mr. Hardiman said. "And screen-based markets are going to allow you to do that, not the old exchanges."

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