GAO raises concerns over stock-price decimalization plans

Government auditors warned Congress yesterday that computer systems used by the nation's top stock exchanges may have trouble handling the big increases in quote and trade traffic that will accompany the conversion of equities and options prices to a decimal format later this year.

In a hearing before a subcommittee of the House Commerce Committee, the U.S. General Accounting Office (GAO) predicted that the Nasdaq Stock Exchange Inc. would have witnessed a 174% increase in quote and trade message traffic from December 1998 to December 2001 if fraction-based stock prices were to remain in place.

But the GAO cited a study showing that such traffic will skyrocket 700% with the planned change to penny-increment pricing, which the Securities and Exchange Commission (SEC) has ordered market participants to adopt beginning in July.

"A primary challenge will be to ensure that the industry's communication and processing systems have adequate capacity," said the GAO's Davi M. D'Agostino, in his testimony before the subcommittee. "The options markets and the Nasdaq . . . face the greatest difficulty."

D'Agostino quoted officials at the Options Price Reporting Authority as saying that upgrading OPRA systems would be a major challenge and "require enough telephone lines to support a small city."

OPRA said it is substantially boosting its message capacity, but D'Agostino said the additional capacity still wouldn't be enough to meet projected demand. OPRA said it is taking steps to stem the tide of quotation traffic, which it said is already straining systems today.

Nasdaq officials said huge trading volumes today are stressing their systems as well. The GAO warned that Nasdaq's planned capacity upgrades may be insufficient to handle the expected traffic surge following decimal pricing.

The GAO also said Nasdaq won't be ready to participate in industrywide decimal trading tests scheduled for April and May this year.

In January, the SEC ordered U.S. securities markets to begin quoting securities prices in decimals rather than fractions beginning July 3. During a six-month phase-in period — from July 3 to the end of the year — stocks will trade in minimum 5-cent increments, ultimately converting to 1-cent increments.

Proponents of decimalization say they believe the shift will make U.S. markets more competitive with international markets that already trade in decimals and make it easier for U.S. investors to understand stock prices.

"The conversion of prices from fractions to decimals will not go as smoothly as many people think," said Lee Korins, president of the Security Traders Association, in a statement.

"With one- or even five-cent increments, prices will change more frequently and increase messaging traffic substantially," said Korins. "Our members are concerned that the markets' information infrastructure cannot handle the additional volume. The inability of the system to report price changes as they occur can cost market makers, specialists and investors millions of dollars," he added.

A spokesman for Nasdaq in Washington said the exchange had never planned to participate in the April and May tests. He said Nasdaq is "evaluating" now whether it can meet the July 3 decimal trading deadline. "We have expressed our concern to both the SEC and to the [House subcommittee]," he said.

The spokesman said Nasdaq trading volume now averages 1.7 billion shares per day, and the exchange is beefing up its systems to be able to handle peaks of 3 billion shares per day within 12 months. New application software and segmenting activity so that separate mainframes can be devoted to different functions will boost capacity, he said.

Copyright © 2000 IDG Communications, Inc.

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