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Vigilance Is Still the Watchword : Investing: The SEC's proposed new rules would aid customers. Market officials say buy-and-hold policy is best for investors.

NASDAQ: Questions About America's Busiest Stock Maerket; Last in a series


NEW YORK — As the Justice Department and the Securities and Exchange Commission look into problems on Nasdaq, what can small investors do to protect themselves in the over-the-counter market?

For the moment, at least, Ron F. Keller of San Jose has chosen the most extreme solution: He says he has decided to stop buying Nasdaq stocks, even though some of the country's fastest-growing companies are listed there.

Nasdaq has become the nation's busiest stock market, with an average daily volume of nearly 300 million shares. As reported last week, the Justice Department's antitrust division has said it is looking into alleged anti-competitive practices on Nasdaq, including possible price fixing by market makers.

Nasdaq and market makers have strongly denied there is any collusion.

Keller, a 59-year-old mechanical engineer who was forced to stop working because of medical problems, says he has spent much of his time over the last year trading Nasdaq and New York Stock Exchange stocks in his individual retirement account. But Keller says that in the last nine months, he has come to realize that spreads as wide as half a point on a $10 stock make the possibility of near-term profits remote. (Spreads are the gap between the price market makers are willing to pay to buy a stock and the price at which they are willing to sell.)

Efforts to get inside the spread by placing limit orders--orders to buy or sell only at a specified price-- haven't worked for him.

Keller says he came to the decision to stop buying Nasdaq stocks on Oct. 14, after watching an interview on CNBC that led him to decide to buy shares immediately in Cyrix Corp., a Richardson, Tex.-based maker of microprocessors. He says he put in a limit order to buy 500 shares of the stock at $37.50, right in the middle of the spread of $37.25 bid, $37.75 asked. And as he continued to watch the TV screen, with the Nasdaq price tape flashing across the bottom, he saw trades being reported right at his price and better. Yet his limit order was never filled.

Keller, who uses deep-discount broker Waterhouse Securities, says his limit orders are almost never filled for Nasdaq stocks. "I feel I'm being treated unfairly," he says.

John Chapel, the brokerage's president, says the failure to execute the order was an inevitable consequence of the "extreme fragmentation" of the Nasdaq market. He says Waterhouse sent the order to an independent market maker for execution, but because that dealer wasn't actively trading in Cyrix at the time, the limit order wasn't filled.

But if the SEC goes ahead with plans to impose strict new protections for small investors' limit orders, this problem is likely to be greatly improved. The SEC approved some new protections for customers' limit orders in June. If it approves a proposed next step, as seems likely, the cardinal rule for small investors on Nasdaq will be to place limit orders, as opposed to ordinary "market orders" to buy at the prevailing market price. Market orders are almost always filled at the quoted bid or asked price, seldom in between.


Under the new rules, market makers would no longer be allowed to let customers' limit orders sit while they trade for themselves at better prices. So investors such as Keller would have a much better chance of getting their limit orders executed, thus circumventing the wide spreads. However, the proposed SEC rule would not require market makers to accept limit orders at all, raising fears that some might stop doing so.

Nor would the new rules fix the highly fragmented nature of the Nasdaq market, which has multiple market makers for each stock and many separate computer systems handling orders for the same stocks at the same time. This means, for example, that a customer placing a sell order through one brokerage house may still not get it filled even though a matching limit order to buy at that price is sitting unfilled at another brokerage house.

Experts say brokers seldom tell customers about the advantages of limit orders. Kevin D. Clark, vice president for trading at Milwaukee-based Heartland Value Fund, says that "retail (stock)brokers in general don't want their clients to realize they can buy stock in between" the spreads by placing limit orders. One reason, he says, is that if the customer pays a lower price, the broker gets a lower commission.

Even with the improvements proposed by the SEC, customers will still need to be vigilant.

Veteran traders say investors should do as much independent research as possible about stocks before investing, and be especially wary of brokers who call them touting stocks, particularly if the broker says he can get it for you at a reduced or no commission.

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