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Workshop: Implementing a Market Surveillance System

Financial Institutions Reforms and Expansion (FIRE) Project

August 20, 1997

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Financial Institutions Reform and Expansion (FIRE) Project US Agency for International Development (USAID/lndia) Contract #386-0531-C-00-5010-00 Project #386-0531-3-30069

Price Waterhouse LLP 1616 North Fort Myer Drive Arlington, VA 22209 Tel (703) 741-1000 Fax (703) 741-1616


Financial Institutions Reforms and Expansion (FIRE) Project

128. T. V. Industrial Estate Worli, Mumbai 400 025

Telephone: 4946630, 4963599 Fax : (91 22) 4963555

Price Waterhouse LLP

August 20, 1997

Mr. L.K.. Singhvi Senior Executive Director Securities and Exchange Board of India Mittal Court, "A" Wing Nariman Point Mumbai 400 021

Subject: Results of Implementing a Market Surveillance System Workshop August 13-14, 1997

Dear Mr. Singhvi:

At the request of the Securities and Exchange Board of India (SEBI), Price Waterhouse LLP (PW) presented the Implementing a Market Surveillance System Workshop on August 13 and 14, 1997 for representatives of the market surveillance department of SEBI and the 23 exchanges in India. The conference was effected under the USAID sponsored Financial Institutions Reform and Expansion (FIRE) project and focused on the critical concepts and frameworks required to develop a market surveillance system.

The PW /FIRE presenters at the conference were:

Ms. Zoanne Nelson:

Mr. David Strandberg:

Mr. Frank Wilson:

Dr. Wittaya Watcharawittayakul:

Ms. Sureka Sellahewa:

Mr. Mahinda Ambahera:

A PW Capital Markets Training Specialist.

Former market oversight and surveillance lawyer with the US Securities and Exchange Commission (SEC).

Former Executive Vice President of the National Association of Securities Dealers (NSAD).

Manager, ~ystems Development Department, Stock Exchange of Thailand.

Surveillance Manager, Colombo Stock Exchange.

Senior Manager, Market Monitoring and Research, Sri Lanka Securities and Exchange Commission.

The main objective of this workshop was to reach agreement among SEBI and all of the exchanges on the concrete steps that need to take place over the next several months to implement an effective market surveillance system in India. A secondary objective of the


Mr. L.K. Singhvi August 20, 1997 Page 2

workshop was to provide SEBI and the exchanges with a live example of the techniques and methodologies used by experienced trainers in the delivery of training workshops for business professionals.

The results from the workshop, including recommended next steps, are included in the enclosed report. In addition, guidelines for conducting a training workshop for business professionals have also been included for future use by SEBI.

If you have any questions, please do not hesitate to contact me at (022) 496-3599. Thank you.

Sincerely,

W. Dennis Grubb Principal Consultant - Capital Markets


TABLE OF CONTENTS

1. EXECUTIVE SUMMARY ............................................................................................... 1

2. RESULTS FROM THE MARKET SURVEILLANCE WORKSHOP ....................... 2

2.1 Workshop Participants ..................................................................................................... 2

2.2 Workshop Content and Materials ..................................................................................... 2

2.3 Trainers .................................................................... · ......................................................... 2

2.4 Evaluation Results ............................................................................................................ 3

2.5 Recommendations ............................................................................................................ 4

3. SUGGESTIONS FOR CONDUCTING TRAINING WORKSHOPS ............................ 7

3 .1 Assess Training Needs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

3.2 Define Workshop Objectives and Agenda ....................................................................... 7

3.3 Develop Workshop Materials ........................................................................................... 8

3..4 Arrange Workshop Logistics ............................................................................................ 8

3.5 Deliver the Workshop ...................................................................................................... 8

3.6 Evaluate the Workshop .................................................................................................... 9

3.7 Train-the-Trainer .............................................................................................................. 9

APPENDICES

A. Conclusions and Recommendations

B. Attendees of the "Implementing a Market Surveillance System" workshop

C. Agenda for the "Implementing a n;arket Surveillance System" workshop

D. Presentations, Case Study and Background Readings

E. Biodatas of Price Waterhouse LLP Presenters

F. Results from Participant Evaluations

f


Works hop : Implementing a Market Surveillance System August 20, 1997

1. EXECUTIVE SUMMARY

On August 13-14; 1997, the Price Waterhouse FIRE project conducted a two-day workshop on Implementing a Market Surveillance System. The objectives of this workshop were to

intJ.:oduce the critical concepts and frameworks required to develop a market surveillance

system, and to reach agreement among SEBI and all of the exchanges on the concrete steps

that need to take place over the next several months. A secondary objective of the workshop

was to provide SEBI and the exchanges with a live example of the techniques and methodologies used by experienced trainers in the delivery of training workshops for business professionals.

In order to act on the conclusions and recommendations suggested by the workshop participants, and to further develop an effective market surveillance system in India, SEBI

should consider undertaking the following next steps:

• Continue Developing the Market Surveillance System - The Core Group should continue

their efforts to draft and finalize guidelines for the development of detection systems and

the databases that support them. The Core Group consists of selected representatives from

SEBI and the exchanges that spearhead the efforts to develop a market surveillance system.

• Formalize the Intermarket Surveillance Group (ISG) - While an ISG has already been

formed in India (according to the participants), it is necessary to formalize the nature of

.the cooperation that should be taking place by creating a Memorandum of Understanding.

• Strengthen Communication Links Between SEBI and Exchanges - There are a number of ways that communication can be enhanced between SEBI and the exchanges, including periodic ISG meetings, dissemination of findings of the Core Group, circulating contact names for the surveillance departments at each exchange, and opening an e-mail address at each exchange dedicated to surveillance related communication.

• Provide Additional Training in the Area of Investigations - In order to take the participants to .the next level of understanding in this area, it will be necessary for the market surveillance staff from SEBI and the exchanges to participate in a training workshop in the area of market surveillance analysis and investigations.

• Develop Training Capacity within SEBI - SEBI should be developing training capacity within its own organization to assume training responsibilities that will be required in the area of market surveillance and other related areas.

In order support the development of SEBI's training capacity, Section 3 of this report addresses some of the critical elements of conducting a training workshop.

Price Waterhouse LLP Page I


Workshop: Implementing a Market Surveillance System August 20, 1997

2. RESULTS FROM THE MARKET SURVEILLANCE WORKSHOP

On August 13-14, 1997, the Price Waterhouse FIRE Project, in conjunction with the Securities and Exchange Board of India (SEBI), conducted a two-day training workshop that focused on Implementing a Market Surveillance System in India. This workshop was conducted at the Taj Mahal Hotel in Mumbai, India.

The objectives ofthe Implementing a Market Surveillance System workshop were to introduce the critical concepts and frameworks required to develop a market surveillance system, and to reach agreement among SEBI and all of the exchanges on the concrete steps that need to take place over the next several months. The workshop consisted of several presentations, case study examples from the U.S. and abroad, and working sessions among the participants to assess current developments in the market surveillance area worldwide and formulate concrete actions to foster the adoption and adaptation of modern market surveillance systems and techniques in India. Workshop participants agreed on a number of actions, outlined in the Conclusions and Recommendations report (see Appendix A). SEBI has agreed that this report will be circulated to the Core Grou]J members for discussion in their subsequent meetings.

2.1 Workshop Participants

Representatives from the market surveillance and enforcement divisions of SEBI and each of the 23 exchanges in India were invited to attend the workshop. In all, 36 participants attended the workshop, including 26 people from 15 of the exchanges (Appendix B). Five of the exchange participants were members of the Core Group, which meets monthly to discuss the guidelines an~ processes for developing more advanced market surveillance systems in India.

2.2 Workshop Content and Materials

The workshop employed a variety of training methodologies including presentations on the framework for designing, operating, and regulating market surveillance systems; group discussions on current market surveillance activities being undertaken by the National, Bombay, Calcutta and Over the Counter Exchanges and future activities for SEBI and all of the exchanges; and case study discussions on the development of market surveillanct systems in the U.S., Sri Lanka and Thailand (Appendix C).

All of the course presentations and case studies, as well as additional background reading materials, were reproduced and distributed to the participants (Appendix D).

2.3 Trainers

To draw upon the wide and varied experience of professionals who have worked or are currently working in market surveillance, the workshop utilized a number of

Price Waterhouse LLP Page 2



speaker/presenters (Appendix E). Mr. Dennis Grubb, Chief of Party for the PW FIRE project, welcomed the participants to the seminar and introduced selected presenters. As the lead trainer, Ms. Zoanne Nelson moderated the workshop, led the group discussions and presented specific topics. Mr. Frank Wilson, formerly the Executive Vice-President with the National Association of Securities Dealers (NASD), spoke about the overall operation of market surveillance systems and the experience of the NASD. Mr. David Strandberg, formerly with the tJS Securities Exchange (SEC) Enforcement Division, presented the Role of the Regulator. In addition, employees from th~ Stock Exchanges of Thailand, the Colombo Stock Exchange and the Securities and Exchange Commision of Sri Lanka made presentations.

2.4 Evaluation Results

At the conclusion of the workshop, each participant was asked to complete a workshop evaluation. Fifteen completed evaluations were submitted and the results tabulated (Appendix F). Overall, participants responded favorably to the information presented and discussed in the market surveillance workshop. Over 93% of the participants indicated that they were "very satisfied" with the workshop; several indicated that it was a very good beginning step and that more training and/or inter-exchange meetings on this topic should be considered in the future.

All of the participants indicated that the workshop was relevant to their current roles and responsibilities. One participant who is actively engaged in market surveillance remarked, "this workshop has helped me to determine our future direction."

Every aspect of the workshop was recognized by at least four of the participants as being most helpful in assisting them to better understand the subject matter. Eight participants, the highest number for any topic, indicated that the Development of a Market Surveillance System and the India-specific topics (Discussion of Market Surveillance Activities at several Indian Exchanges and the Action Plan for India) were most useful. The few topics that were cited by individual participants as being the least useful primarily reflected the diverse ranges of experience (large versus small stock exchanges) and professions (SEBI versus the exchanges) among the participants.

In general, the presenters were rated as being very well prepared, knowledgeable and responsive to the participants. Final comments from the participants indicated that they would prefer to receive materials, both case studies and the results of previous Core Group meetings, prior to beginning the course. In addition, several requested that these types of workshops/meetings should be held regularly (once a year) and that additional practical examples either from India or other countries with multiple exchanges, be addressed.

Price Wat er house LLP Page 3



2.5 Recommendations

In order to act on the conclusions and recommendations suggested by the workshop participants, and to further develop an effective market surveillance system in India, SEBI should consider undertaking the following next steps.

2.5.1 Continue Developing the Market Surveillance System

As suggested by the participants, the Core Group should continue their efforts to draft and finalize guidelines for the development of detection systems and the databases that support them. Pai1icipant~ agreed that each exchange should be responsible for actually developing its own system and setting it's own security-specific parameters. Some systems may be more automated then others, some may use more sophi-sticated techniques for detecting possible illegal activity, but all of them should work within the guidelines established by the Core Group.

By the end of 1997, the guidelines should have been finalized and distributed, and the exchanges should either have a market surveillance detection system in place (primarily the ones that have already started to develop their system) or be the process of developin.g one.

2.5.2 Formalize the lntermarket Surveillance Group (/SG)

The fact that securities can be traded on up to 23 multiple exchanges in India significantly complicates market surveillance activities. In this context, effective surveillance requires the cooperation among exchanges, both for sharing trading information and to conduct case analysis and investigations. While an ISG has already been formed in India (according to the participants), it is necessary to formalize the nature of the cooperation that should be taking place. Should SEBI and the Core Group agree, the PW/FIRE project is willing to assist the ISG in the drafting of a Memorandum of Understanding which will outline the guidelines for cooperation.

This Memorandum of Understanding should be drafted, circulated for comments, finalized and approved by SEBI and the exchanges before the end of the year.

2.5.3 Strengthen Communication Links Between SEBI and Exchanges

Many of the participants welcomed the opportunity provided by the workshop to convene the market surveillance personnel from SEBI and the exchanges and expressed, both in the evaluations and in discussions, their desire to share information and improve communication among the various parties. In the short term (prior to the end of the year) there are a number of things that can be done to facilitate this, including:

• The ISG should conduct organization-wide meetings no less than once a year, either as part of a training event or as internal ISG meetings, where market surveillance issues and




techniques can be discussed.

• Prior to an ISG-wide training event or meeting, the Core Group should disseminate a memorandum to all of the exchanges summarizing the current issues under discussion. In addition, a presentation to the plenary should be made during the opening stages of the event to provide a common framework to all participants. This will greatly enhance the

.ability of all the participants to take part in subsequent discussions.

• If they have not already done so, each exchange should be required to submit to SEBI the name and contact information of a senior-level market surveillance employee. The name of an alternate should also be provided. SEBI should ensure the distribution of this contact list to all of the exchanges. The list should be updated on no less than a yearly basis.

• If they have not already done so, each exchange should be required to obtain an e-mail address, preferably an address tied specifically to the market surveillance department (rather than the exchange in general). SEBI and the exchanges should be encouraged to share infmmation on a timely basis regarding.unusual market activity.

2.5.4 Provide Additional Training in the Area of Investigations

Several of the participants remarked that the workshop was a good beginning in terms of understanding the general requirements for designing, operating, and regulating an effective market surveillance system. In order to take the participants to the next level of understanding in this area, it will be necessary for the market surveillance staff from SEBI and the exohanges to participate in a training workshop in the area of market surveillance an:1lysis and investigations. The PW/FIRE project is currently in the process of arranging for two NASD professionals to arrive in India in November 1997 to conduct training in this area. SEBI should encourage all of the exchanges to take part in this training.

2.5.5 Develop Training Capacity within SEBI

As the market surveillance function continues to develop, it will be necessary for SEBI to think about the types of training workshops that would be useful for both its internal staff and those from the exchanges. Given that the PW FIRE project extends only through next year, SEBI should be developing training capacity within its own organization to assume some of the training that has been conducted by FIRE to date. As an initial step, SEBI management should particiapte in the Human Resources Development workshop created by the FIRE project for capital markets institutions in India. SEBI should also be hiring a Human Resources Director and/or Training Manager to assume the responsibilities for conducting these types of training workshops. These individuals should be recruited and hired before December 1997. The PW/FIRE project is willing to help SEBI both identify the person for this position and train this person in a variety of areas, including training needs assessment, course design, etc.




In anticipation of this step, Section 3 of this report outlines and briefly addresses the critical elements for developing a training program for business professionals.




3. SUGGESTIONS FOR CONDUCTING TRAINING WORKSHOPS

A secondary objective of the market surveillance workshop was to introduce SEBI and the exchanges to techniques and methodologies used by experienced trainers in the development and delivery of training workshops for business professionals. As SEBI further develops its human resource and training capacities it will be increasingly important that its personnel be skilled in the assessment, design, and delivery of training courses for both internal and external audiences.

The steps below summarize the critical elements that need to be considered in order to effectively deliver a training workshop. As indicated above, further instruction on each of these elements can be provided under the FIRE project once SEBI has hired and/or designated a Training Manager.

3.1 As.sess Training Needs

Before developing any training program, the Training Manager must understand the current operating environment of the organization and/or industry that requires the training. A needs assessment phase should be carefully designed to target the appropriate organizations and individuals that will require training, either for themselves or for their staff. These individuals should be interviewed through one-on-one meetings, focus groups, and/or surveys or questionnaires depending on the nature of the assignment. In addition, the organization's strategic plans and related reports should be reviewed. The results should be analyzed and written into a proposal that is presented to and approved by senior management. This proposal should identify the number of training interventions, nature of the subject matter to be taught, timeline for developing and delivering the proposed interventions, the gen-;::ral characteristics of the target audience, and the budget.

3.2 Define Workshop Objectives and Agenda

For each individual training workshop offered by SEBI, the objectives of the workshop should be clearly defined prior to the drafting of a workshop agenda or materials. This will ensure that the workshop will be tied to the strategy of the organization as identified in the needs assessment: It will also provide guidance for the Training Manager in the development of the agenda and workshop materials. The number of objectives and the depth in which they should be covered will determine the length of the workshop. As a general rule, three objectives can be adequately covered over a 2-day workshop.

Once the objectives have been defined, an agenda should be drafted outlining the specific topic areas that will be addressed and the specific training methodologies that will be used to deliver each topic. Training methodologies include presentations, case studies, case presentations, panel discussions, action planning discussions, exercises, computer simulations, etc. It is usually preferable to use a mix of these +raining methodologies during

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the workshop in order to increase the retention of the materials and maintain a high level of interest from the _participants.

3.3 Develop Workshop Materials

Once the management of the department that will participate in the training has agreed on the training agenda, the Training Manager can work with key practitioners and senior management to identify those trainers that will be conducting each of the workshop components. This may include staff from the Training department, staff from the department of the group being trained, professional trainers or technical experts from outside the organizations, etc. The actual materials for the workshop should then be developed by, for example, researching the specific topic areas to be addressed, collecting relevant published material, interviewing industry professionals and associations, and interviewing management of the department to be trained.

Based on the research obtained, course materials; including presentations, case studies, exercises, etc. should be drafted and refined. If there is more than one trainer, all of the trainers should be briefed on all of the course materials.

3.4 Arrange Workshop Logistics

Whether held off-site or in the office of the organization, workshop logistics encompass all of the organizational aspects of conducting a workshop. Invitations or announcements must be issued and confirmations received. Arrangements for a conference room, break-out rooms (for small group discussions), and a registration area should be made as well as provisions for coffee/tea breaks in the morning and afternoon.

Conference equipment and supplies such as overhead projectors, screens, flip charts, markers, blank transparencies, and name tents should be available. Access to telephone/fax and photocopiers should also be arranged. Lastly, workshop materials such as copies of the agenda, presentations, case studies, background reading materials, etc. should be reproduced, bound and prepared for distribution to the participants at the beginning of the workshop.

3.5 Deliver the Workshop

Workshops for working professionals are typically short: 1-3 days duration on average, though they can be as short as a half-day or as long as a week or more. The longer the event, the less likely that the turn out will be good.

It is important that a lead trainer is designated who is ultimately responsible for all aspects of the workshop. This person should be familiar with the content of all of the materials, the ba~kground of all the presenters, the logistical arrangements that have been made and the background of the general audience that is expected.




Training delivery frequently utilizes the U-shaped conference layout, where participants are seated around a U-shaped table and the instructor presents from the open end of the U. Instructors typically will walk up and down the i.riside of the U during the sessions in order to be accessible to all of the participants. Instructors can use visual aids such as transparencies but should not read from or face the screens while talking. Theoretical material should be enhanced by the use ofreal-life examples wherever possible. Also, instructors should draw out questions and comments from the participants during the presentations in order to assess their understanding of the subject matter and encourage them to begin thinking about how to apply these concepts in their own environment.

3.6 Evaluate the Workshop

At the conclusion of the workshop, participants should be requested to complete a written evaluation form. These forms typically ask for a numbered response to a particular question (e.g. On a scale of 1-5, how satisfied were you overall with the course?) plus written comments on the questions posed. Evaluations will generally request feedback on the overall workshop, specific topics that were most/least useful, relevance of the topics to current job responsibilities, quality of the instructors, and suggestions for future workshops.

After the workshop is over, evaluations should be tabulated and the results should be incorporated in a report to the management of th~ group that has been trained. This rep011 should summarize the objectives of the workshop, key issues discussed, the participants who attended, and recommendations from the Training Manager regarding the content of the workshop and/or future training needs. The Training Manager should also use the evaluation results to improve the delivery of the same or other related courses in the future.

Beyond this immediate feedback questionnaire, an organization's evaluation system should also seek to assess the impact of the training intervention. This means seeking feedback (thi:ough formal questionnaires, or over the phone or focus groups, or a mix of all of the above) on how the participants are using the information and knowledge gained at the course in their jobs six months or a year after the event. It also means seeking supervisor input (e.g. is the participant performing better since he/she went to the course?).

3. 7 Train-the-Trainer

Training other trainers to conduct training courses that will most likely be repeated in the future for a different set of participants is critical if the organization is serious about developing training capacity. This is why it is important that all training materials be accompanied by "teaching notes" that provide all of the information needed to effectively teach a particular topic. It may also be necessary.to conduct a shortened version of the workshop specifically for trainers who will be expected to conduct the workshop in the future.



Conclusions and Recommendations


Implementing a Market Surveillance System Conclusions and Recommendations

Over 30 representatives from the market surveillance departments of SEBI and the 22 regional stock exchanges attended the Implementing a Market Surveillance System workshop held in Mumbai on August 13-14, 1997. The objective of the workshop was to reach agreement among the participants on concrete steps needed to develop the market surveillance systems in India. In this regard, the participants came to the following conclusions and niade the following recommendations.

1. Conclusions

In general, the participants agreed that:

1.1 Market surveillance is defined as the process of detecting possible illegal activity, investigating incidences of possible illegal activity, and taking action against members that violate the laws and regulations governing trading activity.

1.2 Market surveillance is primarily the function of the exchanges, which need to design and implement detection systems (either manual or automated) and databases, procedures to investigate possible illegal activity, and procedures for taking action. Some of the exchanges are already developing automated detection systems. Exchanges should refer cases outside their jurisdiction to SEBI for further investigation.

1.3 The Core Group, represented by SEBI and several major exchanges, has been meeting for the past four months to discuss general guidelines and parameters for the development of a market surveillance system. These guidelines will be devek)ped in cooperation with all of the exchanges and a final version will be disseminated.

1.4 Each exchange will be responsible for creating its own market surveillance system within the guidelines established by the Core Group. The smaller exchanges, which have less trading activity and final).cial resources, may utilize a manual detection system.

1.5 As the regulator, SEBI is responsible for overseeing the development and operations of market surveillance systems, investigating cases referred to them either by the exchanges or directly, and referring cases to the Ministry of Justice for prosecution as warranted.

2. Recommended Actions to be Taken

The participants recommended that actions be taken by the end of the year in three areas:

2.1 Develop Market Surveillance Detection (Alert) Systems

All exchanges should implement a market surveillance system that monitors the daily price and volume movements against historical norms of all traded securities. The system should be capable of generating "alerts" when scrip movement falls outside certain programmed parameters. Each exchange should develop its own system -some systems may be more automated than others.

I ,~


Action

Define the functional requirements of a surveillance system Circulate the functional requirements to all exchanges Comment on functional requirements Promptly obtain approval of the Executive Director to implement a surveillance system (if not already done) Finalize and circulate functional requirements

Define internal security-specific parameters for the system - Phase 1: parameters based on percentage change of

volume and price - Phase 2: parameters based on statistical analysis

Develop and implement the system

2.2 Develop Market Surveillance Databases

Responsibility

Core Group Core Group Exchanges

Exchanges Core Group

Exchanges

Exchanges

In order to effectively monitor the market, each exchange should be collecting information on issuers, brokers/members, securities and trading. Some of this is currently being done, but there is no standard format for collecting or storing the data and almost none of the process is automated. The Core Group is now developing standard guidelines for a database on issuers. Over the next four months, participants anticipate undertaking the following:

Action

Develop an Issuer Database Draft and circulate guidelines for an issuer database Review and comment on draft guidelines Finalize and disseminate guidelines Design and develop issuer database Determine requirements for electronic filing by issuers Change listing agreement to require electronic filing by issuers

Develop Member, Securities and Trading Databases Draft and circulate guidelines for the databases Review and comment on draft guidelines Finalize and disseminate guidelines Design and develop databases

Responsibility

Core Group Exchanges Core Group Exchanges Core Group SEBI

Core Group Exchanges Core Group Exchanges

Coordinate Sharing of Issuer Information Among SEBI and Exchanges Discuss potential mechanisms for sharing information Core Group

- possible creation of a database for "national" companies - possible designation of a 3rd-party organization to maintain database

Discuss potential mechanisms for disseminating material news Core Group - SEBI requirement to disseminate news to all exchanges where the company is listed/permitted

2.3 Formalize the Intermarket Surveillance Group and Improve Communication among SEBI and the Exchanges

An Intermarket Surveillance Group, comprised of SEBI and all of the exchanges, has been meeting every three to four months since late 1996. While the exchanges already share some information, there is no formal agreement about how or what

2


information should be shared, nor is there a formal agreement for purpose and activities of the ISG. Participants agreed, to:

Draft a Memorandum of Understanding for the ISG Circulate a draft Memorandum to the members of the ISG Approve the MOU Appoint a senior-level contact person and alternate per exchange Circulate the lists of contact persons among exchanges Discuss requiring an e-mail address for each exchange If required, obtain an e-mail address

3

Core Group Core Group Exchanges Exchanges SEBI Core Group Exchang..:-.;


Attendees of the "Implementing a Market Surveillance System"

Wor.kshop

August 13 - 14, 1997

Mumbai, India


Sr. #

I

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

2i

22

23

24

25

Name

Mr. D.R. Mehta

I Mr. L.K. Singhvi

Mr. C.M. Mehra

Mr. R.K. Kakkar

Mr. Rajiv Nabar

Mr. Anshul Joshi

Mr. Sanjay Awasthi

Mr. Shash1 Kumar

Mr. Sanjay Chandel

Mr. Nehal Vora

Mr. S.T. Gerela

Mr Sanjiv Kapoor

Mr. P.S. Reddy

Mr. Anil Malhotra

Mr. Ka!pesh Shukla

Mr. D.D. Shah

Mr G. Sajay

Mr. P.V. Shreenath

Ms. Mabel Pinto

Mr. Arup Mukherjee

Mr. Raj Kumar

Mr. Anand Kumar Shaha

Mr. Tapas Dutta

Mr. I. Banik.

Mr. Subraya D. Kattige

Organization Designation Contact Number (Permanent)

SEB! Chairman 2850451-56

SEBI Sr. Executive 2850451-56 Director

SEBI Jt. Chief of 2855385 Investigation

SEBI Division Chief 2850451-56

SEBI Division Chief 2850451-56

SEBI Officer 2842787

SEBI Officer 2850451-56

SEBI Officer 6341033



Mumbai Stk Exch. Core Group 2655581/ 2655860/61

Mumbai Stk Exch. Dep Gen Man. 2674880 Srveillance

Mumbai Stk Exch. Dep Gen Man. 2674881 Surveillance

Delhi Stk Exch. Asst Manager 3378700 Surveillance

Ahemd. Stk Exch. Core Group 4867564 465834

Ahemd. Stk Exch. Gen. Manager- 644948011842 Operations 6446733/3858

Madras Stk Exch. Core Group 8571488

OTC EI Core Group 2188164/851 l

OTC EI Manager 2188164/85 l l

NSE Manager 4928405 4932555

NSE Manager 4928405 4932555

NSE Assistant 4946540 Manager

Calcutta Stk Exch. Core Group 2206928

Calcutta Stk Exch. Asst. Manager 2434443 Mkt Survllance

Mangalore Stk Exe Mkt Survllance 441306 Officer


26

27

28

29

30

31

32

33

34

35

36

37

38

39

Mrs. Elizabeth Thomas Cochin Stk Exch.

Mr. T.K. Raghavendra Bangalore Stk Exe.

Ms. Kamala K. Bangalore Stk Exe.

Mr. Pritpal Singh Ludhiana Stk Exe.

Mr. Bhatt Vadodara Stk Exe.

Mr. M.G. Sheikh Vadodara Stk Exe.

Mr. S. Karthikeyan Coimbatore Stk Exchange

Mr. Subramanyam Hyderabad Stk Exe.

Mr. Y. Prataµ Hyderabad Stk Exchange

Mr. S.S. Sarkar Madhya Pradesh Stock Exchange

Mr. Saji Cheria Cochin Stock Exchange

Ms. Surekha Sellahewa Colombo Stk Exchange

Mr. Mahinda Ambahera SEC of Sri Lanka

•

Mr. Wittaya Watcharawittayakul Stk Exch. of Thailand

2

Deputy Man; 339031 Surveillance Deputy Man; 2995200 Mkt. Survllance

I Manager; 3382793 Finance Manager; 412316/17/18 Surveillance ext. 120 Executive 361434/ Director 361534 Assistant 473603 Manager Manager (0422) 315100

-03 Executive 212138 Director 212641/42/43 Surveillance 211638 Officer 212641/42/43 Assistant 432841-47 Manager General 339031 Manager Manager, Surv. 446581 & Enforcement 440541 Senior Manager; 439144-7 mkt. monitoring 345329 analysis & research Vice President, 2632474 Systems Dev. 2540960

2549470 ext. 130


Agenda for the "Implementing a Market Surveillance System"

Workshop

August 13 - 14, 1997

Mumbai, India


WEDNESDAY. AUGUST 13. 1997

09:45-10:00

10:00-10:15

10:15-10:30

Registration/Coffee and Tea

Course Introduction- PW FIRE Project

Presentation: SEBI

Mr. Dennis Grubb Mr. Frank Wilson Mr. David Strandberg Ms. Zoanne NeJ&on

MODULE 1: DESIGNING A STOCK WATCH SYSTEM

10:30-12:00 Presentation: Design and Development orthe Stock Watch System Presenter: Zoanne Nelson • The development process • Needs assessment • Identification of development team and workplan

•.··'

·.?· • Definition of system parameters

12:00-12: 15

12:15-1:15

1:15-2:15

2:15-3:45

3:45-4:30

4:30-4:45

4:45-5:45

• Programming and operation of the system

Break

Case Study Discussion: Designing a Market Surveillance System _at the NASD Facilitator: Zoanne Nelson

Lunch Break

Presentation: Overview of Market Surveillance Systems Presenter: Frank J. Wilson • Definition and purpose of market surveillance systems • System objectives • Process of systems development • Roles and responsibilities of the regulator and exchanges

Presentations: Development of the Stock Watch Systems in India-Update of Actions Taken at NSE and BSE

Break

Case Discussion: Development and Operation of the Thai Surveillence System Presenter: Wittaya Watcharawittayakul

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mURSDAY. AUGUST 14. 1997

l 0:00-10: 15 Review of Day One

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MODULE 2: OPERA TING THE STOCK WATCH SYSTEM I

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12:00-12:40

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Presentation: Operation of the Surveillance System Presenter: Frank J. Wilson • Reporting and investigation • Operational procedures

Break

Case Study: Development and Operation of the Colombo Stock Exchange Surveillance System Presenter: Surekha Sellahewa

MODULE3: ROLE OF THE REGULATOR

12:40-1:15

1:15-2:15

2:15-3:15

3:15-4:15

4:15-4:30

4:30-5:30

5:30-5:45

Case Study: The Role of the Regulator in Market Surveillance (Sri Lanka) Presenter: Mahinda Ambahera

Lunch Break

Presentation: Role of the Regulator Presenter: David Strandberg • Oversight of SROs • Inspection and examinations of SROs • Enforcement Referrals

Group Exercise: Needs Assessment and System Design in the Indian Market

Break

Plenary Discussion Facilitators: Frank J. Wilson, Zoanne Nelson

Wrap Up

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Presentations, Case Study and Background Readings

Design & Development of a Surveillance System Presentation

Overview of Market Surveillance/ Stock Watch Systems Presentation

Operation of the Surveillance System Presentation

Role of the Regulator Presentation

Colombo Stock Exchange Presentation

Securities Exchange Commission of Sri Lanka Presentation

Stock Exchange of Thailand Presentation

Ca~e Study

Background Readings


Design & Development of a Surveillance System

Presentation

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Design and Development of a Surveillance System

The Development Process

Perform a Needs Assessment

• Review current legal/regulatory envirorunent

• Review market services

• [dentify and prioritize abuses. including: - insider irading

- manipulation

- front running - circular trading :]

- marking the close

- other abuses

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Identify and Prioritize Abuses

• History/pattern of abuse

• Extent of each abuse

• Ability to '"flag" abuse

• Ability to investigate and prosecute abusers

• Prioritization

Structure of Nasdaq Market Regulation Department

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Establish System Goals and Objectives

• Specific law/regulation to be monitored

• Specific abuse(s) of the law/regulation that wi 11 be detected by the system

• Actions to be taken as a result of systcm .. alerts

- analysis

- preliminary investigation

- full inv~ation

- trading halts

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Obtain Necessary Approvals

• Draft recommcndatiom and n:sources required to meet goals and objedives 1 - staff

- technology

- budget

Obtain necessary approval - management

- board

• Obtain support of the members

Identify the Development Team

• The development team should have access to experts in: - stock market legal/regulaior,w enVIronment

- 1he broad fmancia! operations of the stock market; economettics

- detecting patterns of abuse in the industry

- gathering and analyzing industry knowledge

- performing staristical analysis

- programming and modelling

- organizational development

Identify the Development Team

• Who shoud be on the development team?

- qualifications

- assignment of roles

- use of internal staff

- use of external consultants

• How much time will each member dedicate to the project?

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Create a W orkplan

• • Tasks

• Responsibilities

• Deadlin~

• Deliverables

• Detailed Budget

Define System Output and System Requirements

• System Output:

-Alerts

• generated on-line during the trading day or off-line during batch processing

• provide graphical representation of data for analysis

- Trade halts

• generated on-line during the trading day

Research the Industry

• Interview experienced surveillance analysts

- methods used to dc:tcnnine alerts

- parameters that define alerts

- steps performed to follow up on alerts

• [nterview other industry experts

- SEC personnel

- Other ""'changes· surveillance departmenrs

- legal experts t ;

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Define Data Required by the System

• Data/information requirements - stock-spc<:ific volume and price monmcnts

- date/time of !Jades - order or exposure sizes

- issuer name

• board. executive lllllllagcmcnl names

• contact informatim

- partier.; on either side of the trade

- other(?}

Identify Sources of Data

• Sources of Infonnation

- issuers

- brokers \

- information services

- wire services

- general industry trends/knowledge

• Obtaining Information - consistent operational procedures

- timely submWion oftbe data

- consistent format

- reliability/integrity oftbe data

Identify Parameters for Capture and Storage of Data

• When information will be captured and processed

- real time. same day. next day, etc.

• Retention of data - readily available to analysts (60 days)

- archived (2 years)

Audit Trail

- reconstruct trading day

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Identify Parameters for Data Analysis

• Parameters for analyzing data - by company specific activity

- by market activity

- using stldistica analysis

- using clurific:aroas

- using patterns and pradic:es

Consider Risk/Resources Issues

• Number of alerts generated by the system

- balance the workload,: number of analysts versus number of alerts

- minimize number of"false" alerts

- minimize losing ''true .. alerts

- consider respoosc time on ''high-volume" days

Select Software/Hardware to Support the System

• Type of software required

• Type of hardware required - to run the system

- for users to access the system

Ability of the system to -grow .. - ability to adapt the system if trading volume increases

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Program the System

• Process for input and update of system data

• Analysis of data within given param~ters

• Output/screens •

• Mmnt~ !t\1!

Address Organiz.ational Requirements

• Objective - integrity \

- credibility

- protection of investors and other market participants

• Nasdaq is one example but the depannent must be organized according to the respective exchange's situation

• Emphasis on procedures that will monitor proper operation of the market

Address Organiz.ational Requirements

• Human resource needs

• Operating procedures

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Determine Manpower Needs

• Detennine manpower needs related to

= ::::~ty of the market 1 ~· f , .. - prescnbed proc:edwa fitl - ttaining required i ~ ·~

- organization of depanmenrlexchllll~

- quality of market desired

Human Resource Issues

• Organizational design/reporting structure

• Job descriptions \

• Recruiting and hiring process

~ Compensation

• Training program

•Turnover

Professional Categories

• Professional categories:

-analysts - investigators

-attorneys

- technical - must be kept on staff after system is developed to~aintain/upgrade the system

-support

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Professional Requirements

• Professional requirements: - intelligent

-educated

- knowledgeable

- committed to the process - dedicated to the work

- well-trained (extremely important)

Sources of Appropriate Personnel

• For Nasdaq: - advertisements in loc\J publications

- some recruiting from graduate programs and law schools

- recruiting from member firms

- recruiting from auditing fmns

- word of mouth

Training

• Exlrcmcly important

• Should be done by persons experienced in market surveillance activities

• Should consist of an organized. comprehensive. training program which is followed by all new hires

• May consist of a mentoring program after the inital formal training is completed

• Insider trading/manipulation cases are difficult to prove; best training in how to do this comes from experienced persons

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Sources for External Training

• Other markets with successful systems

• Developed markets - NYSE and Na5flaq

• U.S. Securities and Exchange Commission

• U.S. Justice Department (for criminal prosecutions)

Develop Appropriate Procedures

• Procedures for responding to alerts - fair treatment of all partils investigated

- standard investigation procedures

- auditable documentation practices

- procedures for coordinating with other exchanges

- procedures for coordinating with the regulator

- procedures/gliidelines for taking action

- procedures/location for archiving

Communicate Requirements to Members

• During the needs assessment phase

- awareness and support of the surveillance function

• During the design/development phase - input data required

- format requirements

- installation of new programs

- training requirements

• During testing

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Communicate Requirements to Members

• During investigations

- standards for responding to infonnation requests !

- timely and thorough respomes to inquiries

• Compliance

- standards for compliance

- repurcussions for not complying

Coordinate with Relevant Outside Organizations

• For the provision of relevant data

- news services • • • For the purpose of conducting investigations

- olherexchanges

- the regulator •

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Test and Operate the System

• Run the system in a test environment

• Run the system in parallel with existing systems

• Begin "official" operation of the system

• Monitor effectiveness of the system

• Monitor workload

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Upgrade the System

• Respond to changes in the laws and regulations

• Respond to changes in volumes of d~ta proeessed

• Refine the parameters for detection of alerts

• Upgrade technology and/or increase staff

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Upgrade the System

• Retain appropriate number of technology staff for system maintenance and upgrade

• When an upgrade is plan\ied: - determine system upgrade objectives and requirements

- inform regulator of proposed system upgrades

- obtain nogulator approval as needed

- design and i;oordinate with analysts and legal people

- develop upgrade

- test and install upgrade

- initiate upgrade in parallel

- provide training for analysts and investigators

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.Overview of Market Surveillance/ Stock Watch Systems

Presentation

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Overview of Market Surveillance/Stock Watch

Systems

By Frank J. Wilson

Agenda

• Market Regulation at Nasdaq

• The Stock Watch System

• lntennarket Surveillance Group '•

The Nasdaq System

• Background - need for system

- market integrity

• Market Surveillance Department Mission - To maintain integrity of Nasdaq Stock Market and

other markets operated by NASO

• Goal - To protect investors and other market participants by

providing regulatory services which ensure investor confidence and facilitate the capital raising process ~ }·

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Structure ofNast1aq Market Regulation_ Department

-I Senior Vice President I I

I I I Central

Administration OATS Director Business Information -~ Legal

(5) (1) (1 support) Management •Surveillance and

(7) Compliance (3) •Quality of Markets (3)

j •Support (3)

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Training I Deputy Director Aaalatant AS$lat.nt Director (4) Surveillance and Director Quality of Marketa

Compliance (1 support) (2 aupport) (3 support)

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Insider I Short Sales I I Fraud I Cuatomer I Market Integrity 1 I

OpUonaand Trading OTC TradingJBlue (6) (9) Complaints (4) Mall!Jngl11uea Trading and Market Practices/Reg M

Compliance Sheets (6) (8) Making Surveillance (11)

( 1 Supervisor)

I I I I I I I Trading Sy1tem1 TMMS TMMS lMMS

Insider Trading I I Blue Sheets I •FIPS (3) •EaatA (7) Rockville II

Weal/Mid-West

(ll) (2) •SOES Select Net (3) •Eaat B (0) (11) (7)

•S11pport (1) . ( ) ;:: number of staff in division

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Structure of Nasdaq Market Regulation Department

-.? 1996 Statistics of the Market

Regulation Department • Alerts 6,247

• Trading halts 911

• Full investigations 230

• Internal prosecutio~s 256

• Penalties assessed > $13 million

• Cases handed off to SEC 136

1996 Statistics of the Market Regulation Department (cont'd.)

• Nasdaq market capitalization $1.52 trillion

• Companies on Nasdaq 5,556

• Issues on Nasdaq

• Initial public offerings

• Non-US issues

6,384

655

418

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The Stock Watch System

Stock Watch

• What is it

• Why is it needed

• What is its purpose

• What are its compo~ents/requirements

• How does it work

• What happens later

What is StockWatch

• A computer syslem designed and programmed to :

- monitor market activity

- identify aberraeoos from historical patterns

- allow for detailed analysis by highly trained analysts and investigators

- where warranted. support disciplinary action or prosecution

• Manual system can be used for very low volume situations - same result if pcrfonned properly

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Objective

• Detection of potential illegal or improper activity such as: - insider trading

- market manipulation

- front-running

- circular trading

- marking the close

-other

.·,f Responsibility for StockWatch

Function • Stock Exchange or Organized Markets

- Finances and constructs the system

- Performs initial review of trading activity

- Performs preliminary ~lysislinvestigations

- Where required, performs full investigation

- Imposes di~iplinary sanctions when appropriate and possible

- Hands off other C3SC$ to government regulator (jurisdictional limitations) with full data developed during investigation

Responsibility for StockWatch Function (cont'd.)

• Government Regulator - Ptovides guidance as 10 whit is c:><pected of marlce!S

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- Qv.,..,.. iUld monitors opo:ntion of the SIOCl<W:atrh '11"""' by the morketplaces

- May have linkup with exchanse •Y5lml<•> - COIKb:!s periodic on site enminalion of exchange StocitWaldt

operations

- Ensures that mck<tplace is properly discharging function

- Con<b:ts detailed investigltlOn of hand ofl5

- Prosccuu:s where markcq>lace docs oot have jurisdiction

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Key Factors for an Effective StockWatch System

• Clear commitment from: - government regulator

- exchanges

- market participants • brokers. investas. clarill!I apncics. deposiroria

• Data integrity from market participants

• Clear rules and laws prescribing expected conduct

·.C Key Factors for an Effective

· StockWatch System

• Ability to investigate/enforce rules/laws targeted by the system - intemolly by the exchanp - externally by the pemment rqpilllOr.o (SEBI in India) or civil

authorities

• Prosecution where awroffjate • System design balancing potential for

detection of improper conduct. cost and workload

• Well Jrained analysts and investigators (the system can't worlc without them)

Operational Components of StockWatch System

• Dataentry - dala entered into detection and data systems

• Detection - detection systems are used to detect potential violations

• Analysis - data systems are used to perform analysis of potential

violations

• Investigation

• Prosecution

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Main Functions of StockWafch System

• Provision of on-line and historical data • Generation of alerts based upon pre-set parameters

• Provision of malhemalical and stalistical lools

• Dynamic update of security and member infonnatiOn

• lntenictioo of multiple data bescs to provide informalion re: parameter breaks

• Graphical representation of data for analysis

• Ability to rec:oofigurc data lo provide differing views and aroupinp Ability to retrieve aged trading data to use in analysis and prosecution., and respond Ill inquiri~complaints ,.

1{1 Tradmg Data Entered Into

System • · Should at least include:

- quotations

- onfer or exposure sizes

- CJtecutions

- price and volume t,.

- market partic:ipmts identity Oii eadl side of transaction

- timing of market activity

- other informalion whidt i:an be utilized to satisfy statistical reviews

Other Systems Used to Assist Analysis of Potential Violations

• Systems to capture: - security /company specific information

- corporate action

- retail account names

- publicly disseminated news

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Data Analysis Component ofa ·-StockWatch System

I • Alert segment - scrip alert ~

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- member broker alert

- trade alert ~-,;··

I i • Data analysis segment "'· ?- ~ ;:.. :1!.

".>)'-",• • .;_ - complimentary to dte alert segment ,_-;<.~(

<.: ·. - audit trail of badinc data

I • idcncif'• m.....,. ll:lpCllllible !Or die fnldint ldiYity

• .. ...... of MCUrily3jMCil'l" inbmalioa c- ini'onblian ·.;: llld..,.,.,... oeliaD) lilrlhe ........ pcrDI ..

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Data Analysis Component of a /

I 'StockWatch System • Preliminary investigation

- chronology of cvcms &elm the is.!uer

·1 - contact members

- contact odacr excliangrt

- analyze bllding IC!ivity to dte chronology

• Report Generation Segment

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I Work • Monitors price and volume infonnation and news

for each listed security vs. security specific

I historical profile

• Looks for abnormal activity on-line and off-line

• Alerts analysts if abnormal activity is found

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Nasdaq's StockWatch Automated Tracking System (SWAT)

• A detection system

• Real time monitoring - looks for abnonnal activity as it OCCllr.i (for

StockWatch team) ·

Off-line (overnight reports) - all issues for insider trading and fraud teams

- this checks stock price movement over a period of days, months or even years

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• Important consideration in analysis - trading information

- internal company activity

- issuer news announcements

- timing of issuer news luounccments

- market information

- company specific information

- industty trends

- broker/market maker activity

- other regulatory information

Data Systems Maintained by Nasdaq

• Systems used by all departments - Market Maker Movement Report and Bid Ask Analysis

Surveillance System • provides • hanl ""l'Y ........ n:play of all mm.. macr _.; ..

..U.icy and cllaases to die imidc •aritct duooghoa1 mc doy

- Research and Data Analysis ~pository (RADAR) • piDpointl d.c ideatity ofdlc sccuritia fum.1 n::spomiblc for tM

Ending. !he pcocUc time 11 whiclt trades took place. how mudl was &ouah• ..i ..w anc1 r ... w11ose -=-

- Audit Trail Access System • provides detailed record or all inside- quotalioa changes. ~

data and ckarin1 daim

- Bridge System - Market lnformalion ,.

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Data Systems Maintained by Nasdaq

• Other systems used by Insider Trading and Fraud - Retail Account Names Search (RANS)

• database of reuil acoount names uncovered durins pm-ioul investigations

- Issuer Information • contains security sp«ific dala, CO<JJCnle actions. ~

olricials, principle stoclcholden, etc

- Current News

• Other systems Wied by Trading Practices - Quote Trade Comparison System

• rul-timc applicalion tlw alerts malyst when market mak<n execute ind .. away limn pmoailmg "1side bid and .. k qoora

.,. Action5 Resulting from System

Alerts • Trading Halts

- Nasdaq requires all participants lo discontinue trading until further notice {usually until infonnation has been fairly disseminated)

• Investigations • • - Nasdaq analyzes system alerts and detennines if

fraudulent activity has occured; may result in:

• no further action required

• disciplinary aaion

• refer to !he regulator for follow up

• prosecution

Summary

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• While statistical models can be built for pinpointing abnormal stock behavior, such is not the be all and end all ofStockWatcb - all StoclcWatch docs is raise red flags

- additional data is necessary to support subsequent action or demonstrate the the move was not improper

- followup action is necessary to give the alert any meaning

- without followup. effective prosecution would be impossible

- most red flags have legitimate explanations

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Intermarket Surveillance Group

Intermafket Surveillance Group / for India

• · Any effective rqulatory system needs intermarket cooperalioa

- especially where cross listings exist

• lnlermarket coopcralioa does not exist in lndia

- exchanges• regulatory tlaffs do not talk to each other

• Recommendalioa

- develop Indian intcrmartet surveillance group

- pattern aftCS" US "lntermarket Surveillance Group"

US. Intermarket Surveillance Group (ISG)

• lSG provides: - mme-MJlll: 6Jr sMrin8 "'!!"ln>fy infonnaiioo

- coordination of regulaiory effu115 1111011g market: cen..,.

- fonun foe discus.sing n:gulatmy concerns

- enhances ability 10 !Wfdl r<glliaa:iry responsibilities

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US. Intermarket Surveillance Group (ISG)

• Organized pursuant to memorandum of understanding (MOU)

• MOU expresses organization',,s.,...... ___ ___ - purpose - policy goals

..: operational sdtemes - organrzation

-t . US. Intermarket Survetllance

Group (ISG) • Organized in 1983 by major US securities exchanges and

Nasdaq

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• Recognized the growing need to share information - related produds for purpose of conducting routine market

survetllance and coonlina"\reguluory effiJr1s

• Subsequently because of proliferation of related financial instruments a<:ross types of marketplaces and national bocders. commodities exchanges and non-US organizations were added

ISG Membership

• Pennils all recogniud market centas worldwide with rules and regulations •imilar 10 lhoseofother participuis designed to detect and dete!- abuses in their marblplaces

• Cun:nt membership

- 21 Nortll Amero:.. ElllOp<UI md A..aaliu scauitics ond """"'1odities cio:hanacs md Naodaq

• Membership commitment - share rqulatory information with odu:r pstic:ipnis a. wlla needed.. as

rcquared. oonlidcatial bmis

• Alloc:ation ofregulato1y responsibilitic:s - u to ccrtaill typa oL viot.tiom which ca111 oi;cur acmss markcu routine

Slll"\-cillance assiglled to: approprialC dcsigaaled pmtic:ipant

- avoids duplicatioo of cfI'on

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ISG Membership (cont'd.) • Meetings 3 times per year open ooly to: - potticiJlO.nt organilatiods

- prospecti.-e panic:ipontl - s..:uni; .. Industry Alitl:lmlliotl Corp;ntiiln - US Securities and E:«:hqe Commd>ioo - US Corrunoditie!I FulWU Tradinj Commission - Occasionally in~ orpniztliocw • ....i. u the !ntern1tica.tl Orpnintion of Securiti<:o Commissions {!OSCO) • ISG mt:tnbers represented by senioc madttl$ surveillanc:c: personnel

• Subgroups address specific issues

BEST AVAILABLE COPY

12


Operation of the Surveilla~ce System

Presentation

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Operation of the Surveillance System

By Frank J. Wilson

Operation of the Surveillance System

• Operational Procedures

- Trading halts ' - fmicstiptico of insider trading cases - lnvatigatioo of manipulation cases

Operational Procedures: Trading Halts

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Trading Halts

• Purpose: to make more certain that all investors and potential investors ha<' available all material infonnation about a company

• Reasons for trading baits: - unusual price « volume activity prior to news

c:oac:emmc the compmy - issuer requab a trading bait pending mectiap m wlaicb

material matten an: being discusacd

- COlll!':"!lY f~ ir C&llllOt pmervc conlideiitiality until news is released

- ongoing manipulati~ activity in a stock

Considerations in Imposing a Halt

• Reluctance to do so from the policy view of free and open mark.ea but may be necessary when:

- there is non-public information - the information is malerial - there has been a leak of material oews - it appears that noo-public matmal infonnation

is being used by S<!IDC persom

Length of a Trading Halt

• Usually until the news is published and widely disseminated by news disscminators plus 112 hour (could be longer)

• Used to be for 2 hours - believed to be too long in consideration of market liquidity and minimizing trade interruptions

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Assumption of Dissemination

• Can never guarantee that all investors and potential investors have the new maJerial information ·

• Must be a reasonable assumption made that at some point in time adequate dissemination has been achieved

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What is Material Information?

• Gcncnl definitioo: iulonaatioo Iha! can be reasombly cxpoclDd ro afre.:t IM price vrt11c eompany's siock; implldS ia'Vator's m'VCSlmad decision

• India definition (DOt "material infomiatioa-but "unpublished price sensitive infonnatioa"'): any iafonutioa which rd:alcs to die followinc matters or is of coat:e111. direcdy or indim;tly, IO a company Ind is aot pncnJ1y lato- oc published by such eompany for general infonutioa. but which if published or knowia, is likely 10

mlltcrially affect the price of secnalies of that comJllllly (see next slide)

Unpublished Price Sensitive Information (UPSD in India

• Financial resula (bod! half-yearly and annual)

• Intended declanlion of dividends both interim and final • Issue or slnres by way o( public rights. bonus. etc.

• Any major expansion plans or execution of new projects

• Amalgamation. mc:TgaS and lake-overs

• Disposal of lhc whole or surutanrially lhc whole of Ilic undertaking .;:,

Sucll other information as may affea the ea.-nings of the company

• Any chanl!es in policies. plans or operations of the company

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Operational Proctdures: Investigation of Insider Trading

Violations

Follow-up on Alerts Generated by the System

• Distn'bute alerts to lll&lysts

• Analyze alerts. plhcr ~levpt dlla • Decide whctbcr to opea m iavesliplioa

• hrsuc inwstiplica

• Coordinate wilh ocher exchanges • Doc:umcatlfilc responses to alcru

• lniliare disciplinary action where warranted and possible

• Forward iavcstiptioa 1CS11its to die g0Yern111cnt regulator

• Esl8blisb lime willlin which IO be clone

Insider Trading

• Unlawful trading in securities by persons who possess material non-public infonnatioo about a company whose shares an: traded. or the market for such shares (U.S. definition}

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Material Information

• No single definition in the U.S.; can include: - information that would affect a reaso114hle

investor's decision to buy, sell or hold a security

- a fact that could be expected to have an impact on the marlcet price of the company's srock

- infonnation that a reasonable investor wouJd regard as significantly altering the "total mix" of information made available

Examples of Material News

• A merger, acquisition, or joint venture • A stock split or stock ditiidend • Earnings and dividends of an lll1USUll natuR

• Aquisition or loss of a significant cootract

• A significant new product or discovery • A change in control or a significant change in

management

• A call of securities for redemption

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Examples of Material News (cont'd.)

• The public or private sale of a signifiant amount of additiooaJ securities

• The pun:hasc or sale of a significant asset • A significant change in capital investment plans • A tender offer for another company's securities • Establishment of a program to make purdlascs of

the company's own shares

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Why is Insider Trading Wrong?

• In making their investment dccisior(7, investors and potential investors are entitled to have available to them all inforrhation which is available to all other investors or potential investors.

• A market is not free, open and transparent without such.

Who is an Insider?

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C•rperate iasiden: ofticen, directors. certain employees, majority or c:ontn>llin1 shard!olders

• Teaporaiy iuiden: 1111derwri1cn. consultants, attorneys. llCCOUlllaRIS t

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• Tq.pers: cocponec or ranpcnry insider wlto pl'!Mde:s iJlfonutioa to a !hard ps1y; lbe lippee dial lntdes Oii die iJlfonnation and/or passes it on to olbels

• N-..c.rporate, C-ponry ef lipper imiftrs: A perKiO

wbo is ncithc:r a corponre or lempcnry in.sider buc who is srill precluded from tndia1 on insider informatioa if the infonn.alioa beloap to someone else. i.e. rcponcr

Discovering and Acting on Insider Trading

• Discovering potential insider lnlding violations

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- primarily by breaks on the Stock Watch system

• Acting oo potential insider trading violations - analysis and preliminary investigation

- full investigation if called for

- preliminary report to government regulator ,:J (90days)

- final report and hand olfto regulator (6 months)

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Formal Investigation Procedures

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Insider Trading Law in India • SEBl Insider Tradiac Jtcgulations • 1992

• Basic pcdullitice

- an insidet who dais in sceurilics or communic:alcs any

i.afonnalioo or coimels fY pence dealing in s.eaui1ics in contravealion al die provisions af Se<:tioa 3 of the rqub1io11S is pilty or insider ttlldiac

• An insider is any pa'.SDll wflo

- is or was conncctcd widl Ille compmy

- is deemed to haw been ~eclcd wilb the c-pany

- is ra50llahly expected to have access. by virtue of sudl coancd:ion. to UPSJ in respccc of securities of the C<JlllplllY. or

- Jaas received or liad acceu to such information

What an Insider Cannot Do

• Pursuant to Sectioo 3, an insider cannot

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- eilha on his own bell.if or on bcb.if of another pmon, da1 in securities of a company !iSfed oo any stock achang<: on lbe basis of any UPSI

- commWliak aay UPSI to any pen.on. with or without his request for svch infonnation. cxoepl as required in the ordimuy cour.se of business or under any law

- counsel or procure any pcr30n to deal in sccruilies of any c-..ompany on ll>e basis of UPSI

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Elements of Insider Trading in India

• An insider 0

• Unpublished price sensitive inform~ion

• Such UPSI is relates to a company listed on a stock exchange

• lnfonnation utilized in any way prohibited by the regulation

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Operational Procedures: Investigation cJf Manipulation

Violations

Common Variations of Manipulations

• Manipulation in the initial public offering

• Creation of pre-offering gray market • Manipulation in the secondary offering • Manipulation to maintain the price of

security

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Indicia of a Manipulation • Sudden activity in lhinly traded sccuricies

• Large scale advcrlising and ocher increased martcetins effortS

• Statemm abou« lbc future price ol a security

• The circulation of rumors

• ConsiSlent late day uadcs

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The Investigatory Process

• Sources of cases

- Monitor ttadmg ~by Stoclc:Watch • price ........ ......... . _., ...... ..,._ • ..,._ ___, liislcrical _

• -.....i ........ prior .. llllllrrial---• price n- cueediml tpeQficd .....- bases oa .amcai dim for

specific pcriodl of'tiloc _. u. day ...a ... ....,.,. • slmp ...... dec!iMs ill ,.b -~by~ -..................... dole

• pell ..... o1...,.. ...i tdli• iftdic:alM of ml!dled orderJ ... wosll ... ..

The Investigatory Process (con' d)

• 5-0un:es of cases continued - General surveillance efforts by exchanges and

government regulator

- Monitor reports in the financial press

- Receive complaints from investors

- Receive complaints from !he i~

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After Potential Manipulation Ascertained

• NltroW KOpe q( ti- b imratiption • Obtain ddailed infomsatioll - moo1 manipulatioat we baed upcn

circ:umRuuial ~ .... all p;.ca of cimnltwial cviclonco -be cumiaed ' ----prier .... - pootprica _

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After Potential Manipulation Ascertained (cont'd.)

• Multiple cxclwlgc manipulatioas - oblaia information from various excbaap as~

• Identify brokas wllo catered Ille trades • Question lbe brokers who entered the trades and lbcir

records of all kinds

• Issuer infonnatioa and officials and large stockholders

After Potential Manipulation Ascertained (cont• d.)

• Question these officials

• Question inYCStus

• HmMI off to gow:mmait n:gulaaoc- if wammted

• NOTE: all these functions ~ be readily performed by exchanges

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Internal Disciplinary Mechanism

• lmporUnt and necessary part o( exchange' s procedures

• Defme the mechanism; specifically provide for

- due process for the accused - written notice of charges - opportunity to n:spood

- opponuaity for accused to have access to cvideace IO be prexntcd apilllt him

- ripr to a hearing

- righl to R:Pf"CSCDwiOG by COGasel - appeal mechanism (internal and external}

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I I I I I I Role of the Regulator

Presentation

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Role of the Regulator

. Role of the Regulator

• U.S. Securities and Exchange Commission's Oversight of SROs

• SEC Inspections of SR Os • Enforcement Referf'als

Regulatory Scheme: SEC' s Responsibilities

• Oversee. supervise and coonlinate marlcct activity

• Establish industry standards • Conduct inspections ofSRO's market surveillance

and other programs to monitor compliance with the: securities laws and SRO rules, and dctca and deter violatioos

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SEC's Responsibilities, con't

6 Investigate and possibly prosecute instances of alleged misconduct may which an: referred to the SEC's Enforcement Division ~

• Impose sanctions or take olher remedial action on SROs. their members, officers, and directors

• Review and approve SRO systems and changes

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Regulatory Scheme: SRO' s Responsibilities

• Day-to-<lay oversight of members • SRO rules must meet cctain aiteria established

by the SEC • SROs arc statutorily required to enforce their

members compliance with SRO rules and securities laws

• To fulfill responsibilities., SROs monitor the market and their member's activities, including through market surveillance programs

SRO~s Responsibilities con 't

• Identify and investigate possible misconduct • lmpose sanctions on members • Refer matters to SEC and others as appropriate

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SEC Examinations: Introduction

4 ~ • Examinations can be routine or "for cause"

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• Examinations focus on SRO prognijTIS, including market surveillance

• Examinations may last 6-8 months, depending on the nature of the examination

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SEC Examinations: Objectives

• To detect and remedy abuses, and punish

misconduct " • To~ incentives f<r SROs to

police their members and avoid SEC sanctions

• To monitor SROs market surveillance programs and their ability to detect and deter misconduct

SEC Examinations: Objectives con 't

• To identify what !be SRO eupt to be doing

• To vuify wflat the SRO adually does and bow well it doe$ it, e.s~ tbc quality of its programs

• To determine lhe extear to which the SRO haz implemented recommendations from previous examinations

• To assess the SRO's automated systems and the abiliry o" the SRO to adapt to evolving market conditions and .. activities

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SEC Examinations: Four Phases

Pn:-inspectior) On-site planrung i~on and

documentation t rmew

lmplcmentation' ~ Prcpararion of and follow-up ...,ti' !oofidential report

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SEC Examinations: Results

• Report and ru:ommendations

• Sanctions foe noo-compliance • Enforcement referrals to SRO, other government

agencies and/or SEC Enforcement Division • Establishes industry standards and nonns of

conduct

Recent Developments

NASO Settlement

Increased Trading Activity

Decimalization

Trading on Multiple Markets

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Enforcement Referrals

• Reasons for referrals: - SEC has broader jurisdiction and aufbority - SEC has more resources - SEC has relationships with othCT government

agencies worldwide - Seriousness of the matter -Policy

Enforcement Referrals

• SRO investigative materials and records arc transferred to the SEC

• SRO becomes a source of infonnation • Typically, SRO investigation ends when

matter is referred to SEC

• Joint investigations and proceedings are possible. however ·

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I I I I I I Colombo Stock Exchange

Presentation

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Colombo Stock Exchange ·

Colombo Stock Exchange ~ .......

Market Surveillance

. by -Ms Surekha Sel/ahewa

Manager Surveillance & · Enforcement

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Zombo Stock Exchange

235 Listed Companies .,

15 Broker Firms

Automated Trading System -

Central Depository System

Colombo Stock Excl?ange ~ ~.,, ... ~'--

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pensions & Trading Halts

Brokering firms • All orders are cancelled

• No oro'ers will be accepted

Listed Company • Orders will not be accepted

• Trade matching_ ceases 0 Existing orders in the book will not be

cancelled

Colombo Stock Exchange ~ •~-;

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Immediate disclosure of material information

Thorough public dissemination

Clarification or confirmation of rumour and reporls

Response to unusual market activity

Unwarranted promotional disclosure

Insider dealing

Colombo Stock Exchange

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rket SUfviiillance , Off-Line \

Features ·

Market Replay

• Recreates the order book for a ·security giving details of all ordefs & executions

• Graphical representation of a security on price & vo~ume with point and click ability where buyers and sellers qan be identified

Colombo Stock Exchange > ~~~.-.

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Features continued ...

Aleris • Price & Volume

Order Book • Pending orders at a given time • Executed orders

Announcements & CSE Messages


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Features

On-line Real-time Market information • Turnover - market, sector

• Index - All Share, Sensitive

• Foreign purchases & sales • Top 10

- Gainers, Losers, volume -

Circuit breakers


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To ensure that the market is fair • Guard against insider trading ~,

To ensure that the market is efficient • Guard against market manipulation To maintain a professional image

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Coiomb6 Stock Exchange " rti.~ ... ~

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Inaugurated on 3td June 1997

First exchange to use Publish and · ..... ~:: Subscribe paradigm

Distributed processing & centralized Database

Software Fault tolerance

Integrated with the Central Depository

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Securities Exchange Commission of Sri Lanka Presentation

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The objects of the Commission Shall be:\·

(a) the creation and maintenance of amacket in which securities can be issued and traded in an orderly and fair manner;

(b) the protection of the interest of investors.

(c) the operation of a Compensation Fund to protect investors from financial loss arising from the failure of licensed stock broker or licensed stock dealer to meet his contractual obligations; and

(d) the regulation of the securities market and to ensure that professional stan- · dards are maintained in such m·arket .

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AUTOMATED SURVEILLANCE MODULES'

• PRICE WATCH - monitors intra:day fluctuations in securities.

• VOLUME WATCH - monitors intra-day volume fluctuations and signals unusual volume increases.

BLOCK WATCH - monitors execution of block trades.

• INSIDER DETECTION - identifies changes in price volume and activity levels before and after news releases. Requires access to CDS. 0

• NEWS PENDING TRADING HALTS - initiates a trading halt if important company news is pending. Enables. members to cancel stale limit orders.

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SCREEN-BASED ',TRADING

Detecting and identifying irregular trading behaviour -• The system contains pre-set price and volume parameters.

I • The market data feed containing symbol, price, volume tirrte and participant Id is matched (real time) against the parameters.

• Trading activity exceeding the parameters is signalled to a surveillance operator.

. • The system maintains extensive audit trails and trade history. • t;, Weekly and monthly analys~s of trading activity is also perfurmed. • Price and volume changes can be graphed to provide visual aids in identifying unusual movements.

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-SCREEN-BASED TRADING

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PRice MOYf:M_ENTS OF BA,TA SHARes

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Date

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Stock Exchange of Thailand Presentation

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I I I I I I Case Study

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Development of the Stock Watch System at the National Association of Securities Dealers

Introduction 1

In 1987, the Board of Governors of the National Association of Securities Dealers, Inc. (NASD) charged the Market Surveillance Department with improving the market surveillance system to better monitor trading activity. It was clear to the Board that the existing system was of limited use. Increased trading activity was generating an inordinate number of breaks during the trading day, each of which had to be followed up by analysts to determine whether or not potential violations had

occurred.

A Steering Committee was appointed to come up with recommendations for improving the system. The Committee recommended refining the market surveillance parameters to produce fewer but more meaningful exception breaks. This would require assembling a design team of internal and external consultants responsible for upgrading system automation and redefining the system parameters. The team would put to use the most advanced technological concepts to enhance computerized surveillance reports for on-line efficiency, enable more effective use of staff resources, and expedite the conduct of most trading investigations.2 The system upgrade would lead to what is now known as the Stock Watch Automated Tracking system (SWA n.

The Pre-SW AT Detection System

The first detection system developed by the NASD in 1971 was a semi-automated system that detected breaks breaks based only on percentage changes in the price and volume activity in each stock; it did not incorporate statistical measures such as standard deviations .

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The department's activity included gauging stock activity against material news, which was primarily a manual process. Each day, an administrative person found all of the availafVe news stories regarding Nasdaq companies that were issued that day. The ticker symbols for the companies that issued news were checked one by one against Nasdaq's Stock Market Companies System (NCS) which showed the price movement of the stock. If there was a certain percentage change in the price on the day of a news announcement., then the stock would either "pass" or "fail" the price test. Those stocks that fai]ed were reviewed by analysts. The system only checked the price movement at the time of the news announcement and did not consider historical trading of the stock.

After several years, the system was reconfigured so that it would also detect abnormal stock price activity by measuring it against the standard deviation. Even with this modification, the original Stock Watch system was considered fairly rudimentary. It only looked at fluctuations in price and volume activity, but did not factor in news or what the market was doing as a whole and how it affected the stock. This resulted in a large volume of breaks, and as trading activity in the market increased, it became overwhelming for analysts to conduct a timely review and determine what was a

1 The case was written by Price Waterhouse LLP, and is intended to serve as a basis for class discussion, rather than to illustrate either effective or ineffective handling of an administrative situation. This case study was undertaken in cooperation with the Financial Institutions Reforms and Expansion project. funded by the United States Agency for International Development (USAID). The author wishes to thank John Desaix, Anne Marie Simmes and Frank Wilson of the National Association of Securities Dealers (NASD) for their informational and editorial contributions to the case. Further use or reproduction of this case study is forbidden without permission_ from USAID. NASD and Price Waterhouse LLP.

2 "Fina1 Report of the Regulatory Review Task Force of the National Association of Securities Dealers, Inc.", March 1988.

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"good" break. Furthermore, the system did not store information generated by the system nor news and statistical information which was necessary for conducting investigations.

Assembling the Design Team

The Committee oversaw the design and development process of the system, and dt~cided that redefining the market surveillance system would require two design teams operating paralJel functions. One team would be responsible for designing, modeling and implementing the actual system. The second team would need to identify and manage the organizational and staffing capacities required to operate the system.

To develop the system, the NASD sought the assistance of several individuals from outside the organization with expertise in statistical and regression analysis. This mcluded enlisting the aid of two Pennsylvania State University professors, one a statistician and the other a business systems analyst. The recommendations made by these individuals were further verified by the counsel of two Nobel laureate statisticians from the Massachusetts Institute ofTechnology.3

Within the NASO, the key team members were an information technology On systems expert who helped to model the system, a mathematical/systems specialist who actually programmed the system, and three to four business analysts who helped develop systems requirements.

Though the team had sufficient expertise in the financial markets, it lacked an expert in finance and econometric finance. The system design process required developing several scenarios related to price activity. In this context, a finance expert would have been very useful. The design team had to depend on the finance k,nowledge of the IT systems expert and the expertise of the statistician from Pennsylvania State University in developing these scenarios.

The organizationaJ and staffing capacity design team worked in para11el with\the systems design team to identify the people processes necessary to operate and monitor the system and its outputs. They determined how the market regulation department would need to change to accommodate the new

system being developed, what changes in procedures would be needed to respond to system breaks, and a plan as well what the department should look like physically (e.g., floor plans). One of the deciding factors of how many analysts would be needed was how many breaks the system would be designed to detect per day.

Identifying the Priorities of SWAT

For the NASD, its surveillance priorities involved maintaining market integrity and ensuring a level playing field. SWAT was intended to look at possible cases of market manipulation and insider trading. Based on these priorities and the limitations of the previous system, the objectives for the design team were to: • develop a new automated stock alert process that employed statistical models that took in to

consideration security-specific parameters. market behavior and the occurrence of news; • develop an automated system to identify and store news stories by stock symbol; • develop a system that could track incidents over time to facilitate investigations; and • provide a split screen multi-session workstation through which all necessary information would

be available to the market surveillance analyst.

System Design Issues

3 Roben Solow and Franco Modigliani.

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The purpose of SWAT was not to figure out what caused abnormal movement, but to give analysts an indication that abnormal behavior existed in the price or volume movement of a partkular stock. It was impossible to come up with a causal model that could identify every factor affecting the price and volume movement. In fact, analysts were not consistent in what they considered a good break. The design team had to conduct extensive research and interviews with variou~ business and financial analysts to gain a good understanding of what parameters the system should use to define a break. This process took apRroximately six months.

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Another challenge was determining the appropriate number of br&.lks the system should detect. If the parameters of the system caused too few breaks, the result might be that the system would reject potentially "good" breaks. On the other hand, too many breaks combined with a limited number of analysts to review them could result in poor follow up of the break.

The design team learned that some of the key signs that the system should observe for potential abnonnal activity included: • price volatility4 • unusual activity prior to material news announcement • unexplained high volume

To better define these signs and refine the likelihood of a break, the design team recognized that the system needed to be tied to how the market as a whole was affecting the stock. Thus, the ~ystem was configured to incorporate market indices such as the single index model and the beta factor.

The team also addressed the fact that infonnation required for the system to detect breaks was not centralized within the NASO. The team addressed this problem in a variety of ways. For material

' information coming through news wires, NASD had to arrange agreements with the news services to code stocks with a symbol in the news releases so that the system could match the news from a particular company with the performance of it's stock. Such arrangements ~re made with Dow Jones, Reuters, Business Wire (the analyst wire), and PR Newswire (the investors research wire coverage).

In addition, the NASO had to work with its member finns to help them automate the submission of customer information to the NASD. 5 Member firms were also required to have its issuers submit material news to the NASD at least I 0 minutes prior to dissemination to ensure sufficient time for analysts to identify any abnonnal activity on that stock prior to the news announcement.

The growing volume of trading activity in the market also presented the team with an architectural design issue regarding SWAT. The team realized that continued growth in trading activity would require that the system keep up with and operate as fast as the market and give analyst more reliable breaks since the on~line analysts had to quickly filter through infonnation on the break. Lastly, the design team recognized the need for a system that could support multiple users simultaneously, which led to their decision to employ Tandem computers; the system was subsequently designed so that each computer would track a certain subset of securities.

With these issues in mind, the design team established the StockWatch Automated Tracking System (SW AT). The actual system design and programming took about 18 months. The system was then

~ Price and volume fluctuations were analyzed from three perspectives: • real time..( stock movements based on market opening vs. closing price/volume) • historical data (stock movement based on current price volume compared to its performance over the last

10 days or more) _ • current performance vs. overall market performance. 5 Customer information was already being requested in hard copy on "blue sheets".

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tested and run in parallel with existing systems for another six months. The testing time took longer than expected since not enough research was conducted up front to understand the full characteristics of price and volume movement. The fact that the price and volume activity were not normally distributed made it more difficult to determine the appropriate distance from the standard deviation, for example. by which to determine a good break. This was where a strong understanding of finance was important because understanding how price and volumes moved was primarily a finance and econometric problem. The system finally became fully functional in 1990. -' Effects of SWAT on Organization of the Market Regulation Department

At the time the system was being developed, there were only 40 people in the entire market regulation department, 20 of which were analysts in the Investigations group. Four years ago, the Market Regulation Department split up into nir:e expert teams, each of which target a specific area of abuse. Currently, the department contains about 130 staff comprised of senior management and department managers, analysts, legal counsel, special projects, administration and support, and training personnel.

When hiring analysts, the NASD looks for individuals with professional experience, preferably in areas such as accounting, business, or law. Individuals have to be bright, motivated, detail-oriented, have good analytical skills, and good communication skills; having a general knowledge of the m~ket is not an absolute necessity, but is an advantage. In addition, new analysts have to go through a one year training program on market surveillance. In the first nine months each new hire is overseen and guided fairly intensively by a mentor specifically assigned to work with them.

Operating SW AT

SWAT was intended to be used by on-line and off-line analysts within the Insider Trading group. Online analysts monitor and analyze breaks based on real-time activity. SWAT iyforms these analysts of breaks related to certain stock; the analyst must then determine whether there is a need for a trading halt.I>

The off-line analysts analyze breaks generated either from cases referred to them by the on-line analysts or from system breaks that result from the overnight batch runs which test each day's data against prior periods.7 An Insider Trading analyst will typically investigate as many as 10-14 breaks. SW AT is now more useful in the investigative process as analysts can track historical information for a particular stock stored on the system. Stored data also includes the news stories linked to particular stocks. The analysts use news services, telephone contacts with the company, market makers, and other internal resources to determine a reasonable explanation for the break.

Each break is investigated using a standard procedural process. Upon completing the investigation, the analyst determines whether the case should be closed with no further action required, referred to an internal enforcement group for disciplinary action, or handed off to the SEC. Generally, a review has to be comJ2.fcted within 30 days.

SWAT is continually being fine-tuned primarily to refine the parameters that determine a '"good" break. For example, the NASO is looking into developing more sophisticated classification systems and models for identifying illegal practices, rather than relying only on statistical analysis.

6 The analysts-monitor price moves with news by looking at the rate of return of the stock since the previous day's close. The next price break that occurs on the stock during trading hours is the price that broke the last time. _ 7 During batch processing, stock movement is analyzed over the past 60 days.


Backgroun~ Readings

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7.2041' --7.2'1'.t

7.101

8.199

7.008

7.128

ll.9M

Utf

8.552

6.995

11.602

. r11 .. 1ut1 ·nance orranl. orrlfif - -t11111 -o 1rlllluai oas~ noH°f~~ :0.ilfl"···- ._ •. ~.~~~J'-"~~- H tnth1's1~_.-· cordlnr to Mr·. Me . ir t::e ~~ · ........ "'~. ·~c.1~{~:~h~-:~~c:ttr.~~nde.:'i;;'.;: . couple raised thefr.deduetlble to ssoo •.

·"Theme people are yery :TUI~... · soclaUOb plan offered throurh the their monthly payments would drop .. 'ble," ~.s. Uccenouys;•:Thq•atan· . Cfntlnnatt .Are• Board -or Reatton.· to S356: ff .they Increased 'the de· age \Then their IHceUhood or needlnr I\ Mr. . Lott. round . · lmurance from ductlble to Sl.000, their premlum : health care Is tnmutnr ~.the,• . ..Nationwide Heilth Pb1n1, a dlYi1ton of . would fall to mt. · · .. · · " ... · ·

1 of that ca~ l~·tncreutnr." Addinr · •Madoawtde 111dranee.Enterprtse In The hlgb-deductlble rout'!mlght be · mon $entm to Ute nmb .or the· unJn. COiumbus, ·oblo, after 1ppJytnr dui1nr more attractive to some people now

sured: corponte downmtnp and· cut· an open-enrollment period. that the government bas created ·tax·., backs In employer·sponsored health The coverage Isn't cheap. The. rree "medtcal.sntnp accounts" for" benefits for. mtlrees; . • . . . . . " Lotts' ·annual premiums are about . the self-employed antfpeople who work .

Robert ' and Lorraine Lott of $5,800 for Mr. Lott and Sl.900 for Mrs. for small businesses. :Under. a four-Cincinnati faced the alannlnr prospect .Lott. And· Mr. Lott stm wlll bave to . . year pilot prorram, people can pul'4 or going wJthout aner Robert, 58, wu pay his: own $540 annual · bUI for. ,chue so-called catastrophic policies

• !aid off from· his compUW"·lechnlctan hlgh·blOOd•preliure medication. . with very high deductibles ($1,500 to Job at A.T&T Corp. In 1995. The Lotti . !'Growing up and working ln ~rpo- $2,250 for Individuals and $3,®'J to were able to extend their 'coverage. · rate America, ·1 never expected to be $4,500 tor famllles) an~ stash a~ay under COBRA, the federal law that p~ . . In thls sltuatlon, .. he says. Pita.St nmt to· Page Cl6, CblU11Ut I ,

. . . . .

~at~ll· l;I-~ 01 _..llC lllllill:Sl downturn In n1ajor Indexes. · The bond market remained generally supportive for stocks, wtth Jonger-tenn Treasurys turning lower only late In the day u investors digested a wave of new corporate bond Issues. · · · World·wtde. stockS fell In dollar terms. The Dow Jones World Stock Index dropped 0.12 to 174.05. ,. .. In major market action: Stocks climbed. On the New York Stock Exchange, 1.461 stocks de<:llned while 1,397 a.dvanced. as 571 mllllotl shares changed hands. · BoDds were mixed; .The 30-ycar bell· wether bond fell 1/32 point, or 31.25 cents per s1;000 bond~ although the yield ~ matned uncbangl!lt at 6.43%. · • 'l1le dollar ~. In New York trading, ~ uie dollar rose. to 1~&139 marks Crom 1.8259 W«lnesday and to 116.10 yen from 115.67 • Set Your CloCk: NASD Plafls.Automatic·Ti-ade'AU.diting

' ' t •, ' •,, ' / ,' •' • ',' ' i t • 0 • 0 ,, •'

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· · By DaoiuH LoHst " , · . · electl"Onleally . dlsdose . to the NASD "Right now we haYe about so,;, of the larger _Nudaq dealers over allegations

StoJ/ le•portn of THE W AU. STltUT JOUIUfl\L Whether· the order WU to buy ,Of tell punJe. 'l'bls 'frill a1Ye US 1009fJ Of the tJ>at they .. backed away .. fr:om their quoted

· The Nation&! .AnoclaUon ot' Securltlet : sham, what time lt occurred, and whether puule, .. Mr. Canrtano say1. · prices. . · · •

Dealers, Mnmnr the tut major mandate ·: the trade wu for a dlent or the nnn. · · The system would have ·the biggest . . The NASD disagrees. saying It recently.

of Its settlement wt.th federal rerutators · But If the NASD auspects. for Instance. Impact for active lnTeStoi's who are frut· has been more vigilant In policing the

last year• wm f.OOft propose 1, system· that that a ttader used knowledge or an lncom· tn,ted that their broters arbttrarlly refuse mai'ltet. Indeed,· several larger trading

could speed up the NASO s CJetectton · tng order to mate a trade In advance ofthe "to carry outthelr trades or neglect to tell ·. flrms say the NASO has been cracking

ot trading abuses by dealers on the Nasdaq -' customer. the NASO now bu to call the them or big recent trada that c:Ould affect down. "Ftrms have been Inundated with

StocTkhMarket. ~ · ted tb _ filed with firm and aak for tnfonnaUon such u when , tl\e price at which the customer'• trade · lnqulrfes from the NASO. which has been

e proposa., expee U'G . · the customer's order was nrst placed at the orders are execu~ed Under the proposed much more aggressive In ronowtng up on

the Securities and .Exchange Commission nnn. which trader executed the trade. and system, the NA.SD says It WUI be able to these eomplalnts,.. says Judith Poppa·

In the next few wee~ •. would. requlni when It was relayed to the trader from the tract and punish dealers who break the lardo~ assistant general counsel ror the

Nasdaq firms to give lTte NA.SD a dally . sates or other d•k at the nnn. · rules more eully without watunr for Securities Industry Association, the major

electronic record or 26 trading detatls on Trail Record . · Investors to complain. · · trade gr00p on Wall street. .

every transaction a nnn handles, from tile ... ·. . . . . . . . • . · · · th .. A

moment a custome~ calls a broker. ·, .. · .The new audit system, as propoftd, O'fercomlng Skepttdsm . . ··Under e proposal, which must .,...

The system, ¢led OATS, or Order .. .would force fli'mll to. provide .such data · · · n · who · approved by the SEC after a comment

Audit Trail System, wai one orthe require- .. · automatlcaJJy each day. "I wm now be able alt ~\:°~~ tra:!:: at.!"'alt~ vl~s Of • period, as many as 1,200 nrms will have to

ments dictated by Ute· SEC In a\ c:rlttca.t.~.; to reconstructt without having to wait for ege a Y ne.., are ms . l)'DChronlze their computer and other

August 1996 report 'Ori ·· rallum · by the ": · any ctocumentatlcm,.. Whether·· i trtde~ tradlnr vlolaUons are ateptlcal that 1 new ·.. . clocks so traders can't claim their c~?Cks

NASD, the Industry's primary self ·regula· ' violated a nde auch u the one prohlbltlnr audit system ~U stop 1~· · . :• . 1'!re faulty when they time a trade. The

tor and owner of the Nasdaq Stoek Market, rront·runnlng, or trading ahead or a client,. . "It sounds llke' a great Idea. hut ~ :· keY. to. a~. audit trail ls to have a tttne

to police abuses by members.. · · '· · · . says James• C&ngfano, senior vtce presl· ltre~dy ha Ye more tban enough !~forma· sequence. says Ms. Poppalardo. Firms

CurrentlY,, the NASO collects ba.Slt data dent for martet regulaJton at NASO.Reau:- t~n and they do nothing with It, argues . th(\t now use Imprecise ttme;stamp ma.·

on trades after they are executed. ·Traders · 1atton. Stieb reports now take up to 10 days Josh Levine, a trader with Bir J 8ecur1~1es chines to track trades wouldn t be able to

are required within 00 seconds of a trade to · tO compile, be 1&19.. . . . · In New Yotk, who frequenUy cluhes With . Pletl:ft Tum to Page CIS, Column t .J

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hlgner yieia.s uuw • · h equivalents. ·

Late ln New York )N ...

was quoted at 1.8339 __

marts late Wednesday t' U.S. currency also W;" ·

yen. up from 115.67 ~ Sterllq fell to Sl.6742 noon Friday iJl -=~ tradlnc at Jl&.20 yen sterlln( was at Sl.6T ....

Tr&ders nusbed &"":

day blah of i.8400 ~-- -since July 12, 1991. aplut tM mart -=~ doBan for SWla ~--currency tO 1.5100 : time It traded blgbe CUl'reDCf WU Oil :·

lntraday bf&b wp L

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tar/mark mmmr• Swiss fraDcS. ftUOI

blsber·" said ~:: analyst at Forelp .

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I he luncheon room of the H New York Stock Ex-~ i change is paclced with the ~ ~ players and friends of the

~ 1~ J?hn F. Kennedy Knights .; ~ high school football team.

:;~ At a podium. Ridmrd A. Grasso -l:J'J .... &.._ ... ,:___ ' ::: ~ o~mau of the NYSE. is recounting

I ; a story. "Someone once asked me ·~ whez; my family's wealth .came

~;; from. he tells the crowd of mner

How Chairman Dick Grassoistransforllling

the New York Stock Exchange

finance. The t'l-year-old Grasso. who left New York City's Pace University a year before graduating, had no family oonnections or pedigree to help launch bis career. That Grasso. 50. the first chairman to rise from the NYSE staff. was able

·to g<t.in the top spot at t.he ~el of capitalism in June. 1995. is a remarkable accomplishment. More than just a personal victo~. ho~;; ~ city students. who had no pla~ to hold their awards dinner

I~ ~fore. the ~YSE ~onated it! space. ·:1 said: '011. gas, al?d :: rubber. I grew up m Queens. My relatn•es ran an Exxon sta

~~ tion near LaGuardfa Airport ...

'~;; Thirty years ago. Grasso walked through the doors of one

of the most insular and tradition-bound organizations in all of J

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58 BUSINESS WEEK I AUGUST 4. 1997

ever. it signifies a new era at the exchange. an 'lJ'a ~ which the SYSE's efforts to recreate itself are paying off as it moves aggressively into new markets and counters a host of competitive challenges.

It's 11 Wall Str~t. not :-l.:\5DAQ, London, or Tokyo. where many of the world's leading companies want their stocks

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listed. Of course. the ~"YSE's fortunes and those or other U.S.

exchanges are being buoyed by the long bull market. But un

der Grasso. not only is the NYSE turning the tide and re

gaining precious market share in the trading oC NYSE-listed

stocks. it is rapidly increasing its roster of foreign companies

and is attracting a record number of NASDAQ transfers, in

cluding high-profile teehnology rompanies such as Gateway

2000, America Online. Bay Networks, and Iomega-and is re

serving the ticker symbol .. M" in the hoPES of one day snag

ging Microsoft. Grasso's ambitions don't stop there: The NYSE

is also in hot pursuit of initial public offerings, where s.~AQ

has long reigned supreme.

TitOUllt.ED Rfl/AL Scandals and regulatory problems in the

S • .\SDAQ stock market in recent years have thrown the !-r'z:>E's

reputation for integrity and strong regulati-On into stark reliet:

I "'The ~ ·ysc: has been under constant competitive attack for the

last 20 years. and the.re was certainly the threat that :-1..\SDAQ

would completely subsume their own role as the trading

market of choice," says Samuel L.. Hayes III. a professor of

investment banking at Harvard business school. "But I per

sonally trunk NASDAQ has blown it." Events at NASDAQ have

"brought into question the integrity of that marketplace.

and I don't think

there's been anything

comparable to that in

the SYSE." And while

Tokyo and London ·

have enjoyed periods in the last 15 years when their stature

as financial C1'?nters was rising at the expe~ of New Yo;;.

the !iYSE is now benefiting from "the swing. in the balance. of

power toward New York as the most important _financial

center," says Hayes. ''The NYSE is still seen by fori:ign com;:

panies as the prestigious market in the world to be listed on.

Clearly, the NYSE is enjoying newfound momentum. The

BUSINESS WEEK I AUGUST ..t l997 59

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• • • • "·:·'"'"''°· _i GATES BAIT The exchange is reserving the ticker symbolMJ . teehnology prow.im:; stres~ by former SYSE chairman John , for $1.+'> million. up :~"f from the high prire in J. Phelan •. Jr. in the l!Jl:iO!; set a foundation that ha..; e!labled ~ l!ICJ:l. The latest puhlic :-;alt> wa.: for $I.:1.'> milthe !l:Y='E to become more highly automated and CO."t~ffi- 1 lion. ~o wonder: The bull market ha..; sent dent than ever before. But whether SASDAQ has really blown : volume to a daily a\·erage topping 5()0 million it i~ debatable. In a way. a fresh battle i..; only be¢ruling. sA...;. ! $hares. ham.lleil \\;thout a gliteh by the sYsE's DA'-1 remains a ,:mart. aggre~.;ive. well-fund~ compE'titur. I~ trading :-:y~tem. up from an a\·erage of 20'2 parent. the National Association of Securities Dealers. or ; million in 1W2. In l!JCJ6. tht> SY:'E had net in-SA...;o. has :."trong new leadership in Frank G. Zarb. a well-con- j come of $i4.4 million on revenues of $561.5 nected businessman with a solid history of turning around I million, with more than -tin of revenues com-

~ troubled organizations. ing from li"ting fees. and the rest from fees in- ."It ~·ou.ld be a great eluding those for trading. market data. and mistake to sell short use of facilities and equipment. 11lat compares the competitiveness of with net income of $56.7 million on revenues of

NASDAQ in the future." says William C. Freund of Pace Uni- $.500.8 million in 1995. versity's Graduate School of Business and a fonner ~mm Grasso's SYSE is also regaining market share. at the !l.'YSE- "They're going t.o be reorganized and aggres&ve. In 1996, it wrested back some of the share it In some ways they'll move more toY.-ard an auction-market lost in the late 1980s and early 1990s when its setting, toward the ~-YSE model" As with the SYSE, NASDAQ's portion of the volume of transactions of SYSE·

volume has mushroomed, and NASDAQ is also attracting record listed stocks slid from 86.2% in 1988 to 81.?% in numbers of companies, though most are much smaller. 199'4 Now. the SYSE's market share is bs>..ck

ln the ·war between the exchanges, the winner will be up to 83% and has inrhed up in threa of the the tndir.g system that oft'ers the great.est efficiency, the best past four years. More significant is its gain in service. and the most liquidity-at the lowest price. But the distnbution of trades. In 1005, the !JYSE got there are other winners: The companies 73.2% of the total number of that will get ~ and more open mar- IYSE SOT f11CES trades in NYSE-listed stocks kets for the trading of their stocks and llSE ID~ made on U.S. exchanges, up the .inVestors, both big and small. who will uoa from 70,2(1, the year before get the most for their investment dollars. tt-a'll .,_ and up from a low of 65.2% in 1992

While the main battJe is between the S)'SE l..l'IO- atnarlalUJl'lilUl'SE Crucial to the !ffSE's future __.i., is its IElll!El91f. Ill "SOJ" 5" "'" wa

and SASDAQ, the two markets must also con- progress internationally. In 1997. one out of tend with a new breed of competitors mass- every four new Jic;tings is a &reigrl compa.ny, ing on the sidelines. Such alternative trading and such listings have almost tripled in ~ systems. which include ~ electronic past five years. to 300. Grasso hopes to list oommunication networks (Eels) such as In- between 500 and 600 non-U .S. companies by stinet ('.orp.. as well as the newer Bloomberg an>. The NYSE cakulates that the tA:Jtal mar-'Il'adebook, allow institutions to trade among 0

11 • .., .. ti 11 13 .,. 1S -,. 11· ket fbr intematima1 companies eligible to themselves and avoid any middleman. 1be •llOJ.litiliSGrlOJAIS ·ASOF•tt list~ the SYSE is $8.4 trillion. 1be NYSE computerized systems are becoming more ...IS 11111 llllR Im jcj.ned other U.S. euhanges in movq to popular with powerl'ul institutional traders. n:=::"' · allow price quot.es in sixteenths. rather than who view them as a low-cost alternative.

5111 ~•• eighths. and Grasso recently announced that

The Securities & Exchange Commission re- the NYSE will be able to quote prices in dec-cendy asked tor comments on how regulation 11111 i:mals, rather than fracticms, perhaps as soon needs to evolve along with these new ven- as April 1998. That brings it in line with tores. It noted that "alternative trading sys- • wcdd stock markets and fits nicely with the terns handle ahno:.-i 20'li of the orders in !'O'SE'5 overarching goal to be the first '"truly over-tbe-aiunter stocks and almost 4t;; of or- global.. stock exchange. "We have the op-ders in securities li...c;t.ed on the ~-YSE." That's portunity to redefine this franchise for a very up from t-n in 1YrC ~ and 1.44 in ~"'i'SE-

0 long period of time." says Grasso. --xbat dri-

Jisted stocks in 1991. Eo; •1oh.une is ~ a 11 • .., .., 11 w !3 .,. !S "' 11- ves everything we do."

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boost from new SEC rules. Among other ._. .. 91116 ·A.Sou•lll To lead the international charge. G~ things. the rules require some customer or- ca .. ,,•uiroDOWU recruited European investment banking _ ders to be displayed t.o a broader audience. hotsMt ~rges L. U gewc in 1996. He also XASDAQ arid some regional ex.changes are ex- expanded ffie SYSE s network Ol' Inte~-ploring links with the Erss. which could tional Advisory Committees. adding a Latin pump up their market share. America Committee headed by Carlos Slim.

.Meanwhile. business is booming on the the head of Telefonos de Mexico, and " SYSE. Membership prices are rocketing. broadeoed the Japanese Committee i~to ~ Memberships. called seats. allow finns to the A.s1a-Pacific AdvisOry Conunittee to m-

trade on the Hoor of the ='\SE. Seat prices elude the entrepreneur-rich Pacific Basin. ~ hit. an all-time h.igh in I~ when one sold Grasso himself traveJs .extensively abroad.

~ UTTI.At POINTS COUNT

} (i;;;~~~-.~-~~~-~-~~d;~~i-mal pridng .= was unexpected-but praetit-a)

-eo BUSINESS WHI< AUGUST 4 1997

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OUT CW Af'JHCA. ~ SYSE's international roster is led by companies from Britain. Canada. Chile. and Mexico. Privatization,; such as the IPO uf Gennanv's Deut!'-:."htc" Telekom in 1996 ha,·e been a ireat boon for

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~I': · " hopes of someday luring Microsoft into the fold ;.·., . ~

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tr.uling of their a..;signed stock..;, witlu.lne.~.far..each ~ st~~k. If a ,.:1gn1ncanTUii15aLince between supply and demand . develops. the specialist must :¢ep in ~th his finn's capitaJ to , buy or ,-ell stock and provide a ><fair and orderly market." In · CJ'ie \·~t maJoi'lty or IWe!'. reta:ll bl'l1ers meet and are exe- ; ~,

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~TEINS AND FLAT SCREENS ----------------------·-------~-------The ~"YSE is focusing on high-

• cute<l 'Aithout the speciali.;t ,.:tepping in. ' To speed up the proces.. .... the :-OYSE has invested $1.2 billion

in technology during the past decade. "Technology is the saving grace." says the :-ZYsE's president. William R. Johnston. ' "We're running this exchange with fewer people than ever before." Now. the SYSE features the world's largest com------------- mereial installation of

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Oat-screen, high-defini-tion display panels and is working on a wireless communication system to make ftoor brokers more effitient. About 85~ or all trades in SYSE-iisted stocks, or 40% <>f the dollar volume of its trading, flow through the sYSE's au-

o tomated order-handling '11 ·113 '19 '90 '91 '92 '93 14 "95 "% system. The SYSE can

• lUl&R ~~~oawa process 2.3 billion shares a day. more than 4

times its average daily volume, and plans to be able to process 3 billion by the end of the summer. NASDAQ haS sped up an overhaul an~ expansion of its network. which can process 1 billion shares a day. It plans to be able to process 2 billion by early 1998.

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\ tec:h recruits-Gateway :woo bought mascot Arian_n, to the floor when it was listed-while promoting its 0\\1l $1.2 billion investment in technology

In the screen-based NASDAQ market. _som~tine; dealer§. ca11ed market makers, have traditionaIIy '! interacted eleetrorucally with JUSt \ the NYSE. But the Big Board is looking to all comers oC the about every trade. A customer's broker sends her order \ globe for new listings. uu I were just taking India, Brazil, to the market maker offering the best price. Market make?s \ and China, those three probably represent over the next five profit from the gap. or spread, between the price they pay , years a huge reservoir," says Ugeux. Last year, the NYSE list~ to buy shares and the price they offer to sell those shares to i

ed its first Russian company. Vunpel-Communications, and its another investor. Tu be sure. NYSE specialists. who get com- \\ first Ghanian company, Ashanti Goldflelds Co. missions, also profit from trading for their accowt. but ~ASDAQ is also looking abroad Cor growth. .. Intemational will ~ customer orders taking precedence over soeciali§t be a key battleground for us," notes Zarb. ~ey're rormida- taiif's spfillllD IW, ti CVN!Ri fn fiP narrower on the NYSE. ~

ble. and we are, too. We have to be a little better because ft SASDAQ's growth since its inception in 1971 bas been phe- ! don•t have the years of history and tradition and image." nomenaJ. but its fundamental system of trading has come ~ Both the :-rYSE and '.'lASDAQ's globaJ ambitions are hampered by under attack in recent years. It was the subject of a Justice ~ the slow progress in developing international accowiting st.an- Dept. review of whether, NASDAQ dealers colluded to set ~ dards acceptable to both the SEC and other countries. stock prices.. In August. 1996. the SEC censured the NASD for :. To be a truly global exchange, the S"'!"SE will need to offer failing to halt widespread prke-fixing on SASDAQ. The NASD ~ more global products and trade so-cal.led ordinary shares-for- agreed to pay at lea& $100 million over five years to upgrade ~ eign shares listed directly on the :.n:·sE-in addition t.o the usu- regulatory operations. and the regulatory effort is now sep- ~ al ~rican Depositary Receipts. The SYSE is building capa- arate from the operations of the NASDAQ stock market. ~ bilit1es to trade non-U.S. shares in ordinary form. in dollars Now, the new order-handling rules instituted by the SEC ~ and possibly also in one or more other currencies, says Robert are changing the trading landscape. The rules, which create a ; G. Britz., the NYSE's head of operations and technology. more level playing field for small investors, are being P~ ~ Sl"EPPMG IN. In their forays overseas. NASDAQ and the SYSE in on :SASDAQ stocks and also apply to the ;NYSE. For the nr.st : are talking up the \"il'tues of their particular brand of trading. 500 stocks phased in. a :SASDAQ analysis found the average ~ Long at the heart of the :-<YSE·:SASDAQ clash has been the is- quoted spread shrinking by more than 30%. If spreads eon- ~ sue of which rr.arket has the better trading system. In the tinue to narrow as more of s~OAQ's stocks come under the ;: sYSk'._s hig~mated. but ttnnr-~ wtem; S"i sit meme- .

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1 rules. companies thst added wide spreads to their list of ~ be:rs Ciiled specialists must maintain an orderly market in ~ reasons to move to the NYSE may be less inclined to leave .:. -

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TAKING A TOSS NASDAQ. But if market mak---------------- ers are loath to take the Foreign privatizations same level of risk for a now and startups are prime diminished reward, there

may be less liquidity and prospects. Last year, the new rules could lead to Vimpel-Cornmunica- greater swings in NASDAQ

stock prices. tions became the first One competitor the NYSE

Ru~an company to list doesn't worry about: the r . · American Stock Exchange.

. · After 22 AMEX companies transferred to the SYSE in 1996, "there aren't that many companies left on AMEX that fit our listing standards," says L. Paige Thompson. the SYSE's vice-president for domestic listings_ While ~e ~SE ~d N~~Q are f~ on many of the same comparues, AMEX IS adopting a new mche strategy as its equity business shrinks to an average of just 22 million shares a day. While continuing to focus on its successful options business, it is pursuing a novel strategy to build investment banking relationships to help draw a tier of smaller companies that could become less attractive to NASDAQ dealers wider the new order handling rules. Amex is offering aggressive investor relations support programs to increase the companies visibility.

Although Grasso won't say it, N;\SDAQ's travails with the

NEW FOREIGN LISTINGS llf AMCORD

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B "81 '81 19 .,., .,, "92 '93 ·94 "95 16

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regulators have given the NYSE an edge in persuading companies to hop over. In the U.S., the tech sector is the main battlel:~und, and Grasso

isn't shy about coveting what he calls NASDAQ's ''fearsome foursome": Microsoft, Inte~ Cisco Systems, and Amgen. In explaining why the NYSE moved to cap the maximum listing fee at $500,000 last year, Grasso notes that since listing fees are structured on shares outstanding, a company such as Intel Corp. might have had a listing fee ot $2 million or more.

Tu be where the action is, the NYSE opened a small office in Menlo Park, Calif., in the heart of Silicon Valley. The Big Board's attempt to woo companies from NASDAQ has "escalated dramatically," says Sanford R. Robertson, chairman of Robertson, Stephens & Co. "fm surprised they haven't done it sooner." Says Danie) H. Case III, president and chief executive officer of Hambrecht & Quist. the high-tech investment-banking finn, which listed on the NYSE last year: ~y spent more money and are working aggressively for it." NASDAQ is also beefing up its Menlo Park office and now has 18 people there. NYSE PERKS. Both NASDAQ and the NYSE provide some form of advertising support t.o attract and retain companies. "We'll promote a new listing so a company can say to themselves that if' the NYSE includes us in their advertising or seminar program, that will, in essence, bring down the cost of listing," says Grasso. "It's an investment we're making in the merchandising of an important listing event." The NYSE throws in perks such~ the use of its boardroom for OOJlllmlY functions ml analyst meetings.

NASDAQ's president, Alfred R. Berkeley III. doesn't shy away from saying how much the NYSE's wooing ot its premier

THE UNLIKELY LIFER FROM QUEENS

A bout a year ago, Richard A. Grasso, chairman of the New York Stock Exchange, was bobbing and

weaving in a boxing ring. As part of a charity bout attended by the Wall Street community, the short, slight 50-year-old sparred with Roy Jones Jr., the International Boxing Federation super middleweight champion at the time. The two put on a great show, helping to raise $1.5 million~r the U.S. Olympic Committee.

Grasso isn't your typical ~SE chairman. He's the first "homegrown" one, having joined the SYSE's listing department in 1968. Grasso didn't plan on be-

62 BUSINESS WEEK I AUGUST 4. 1997

coming a lifer. "I was going to use it as a platform to go somewhere else," he says. "I wanted to be a trader." Instead, Grasso, who is described as a shrewd behind-the-scenes operator with superb people skills, rapidly rose through the ranks and was mentioned as a candidate for the chairmanship seven years ago, when he was president. The board ultimately appointed William H. Donaldson, but one of his mandates was to prepare Grasso for the top slot, which he got in June, 1995.

Grasso grew up a subway ride away from the exchange in the lower middleclass neighborhood of Elmhurst,

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Queens. He's loyal to his roots: Until recently, he still owned the apartment in the fi.v~ry walkup where he was raised, though it bad sat empty for years. It was in Elmhurst that be bought his first stock, at age 13, with $1,000 saved up from a job in a pharmacy. The stock was an airline and_ ~as "experiential investing: I used to VlSlt LaGuardia and watch the planes."

1bday, he, his wife, son, and three daughters live in exclusive Locust Valley, N. Y., and also have a home in the Hamptons on Long Island.

Charit.able and civic activities take up a good chunk of Grasso's time. He is

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·Hut if not. we're gmng to be th~,:r ,.,,rst ent>mv. :heir .,.,orst

nightmare." Berkeley ,;ays that Pxcept when ·listing is.~ues

come up, he doesn't spenri much time thinking about the

:-<YSli'. Instead. ''we think about a new pricing curve where we

have · ery ,.;ignificant competitors that are emergmg •m the Internet," he says.

Tech companies that left 'A.'IJ.\(< for the 7'Y.'E cite a 11.~de

:-..uige of reasons for -"\\itching. "We thought it would berume '

more appropriate as we became more estab1bhed," says Scott ~1WTa_v, Learning Co.'" 1 ·ro. Ylu.rray. along with lome~ (<Jrp.'5

trea.;.;urer Robert .I. ;-;immons. abo cite high levels <Jf CU.."tumer :;en.ice from their specialist. "You end up 11.ith one market

maker more familiar 1.1.ith your stock becm1se they are the only trader." says Murray ... You ha\·e betU?r visibility on who the buyers and sellers are."

The :O.'YSE's prestige internationally is also a selling point. For America Online l'EO Stephen '.\I. Case. moving to the :--oY::E was

about "impro~ing our global profile. The :-;YSE has the prestige and the global ; each" . .\OL wanted as it pushes into new markets in Europe and . .\sia. Also. ''v.·e felt an

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du.~ <Jf c·umpanies to the .'iY:;E. A record % L'.:3. and nonU.S . . 'i..\:'DAQ companies defected to the :-.IY:'E in 1996, up fr0m n2 in l'.)95 and -15 in 1W4, but "t:iere wa«m't a break in

the <lam at all." .-;ays .John Wall. :-.1A.;o;r1AQ's executive viceprP~ident for market ~ervicP:'. "We lo~t

,;ome good-.-;ize companies. such a:; Bay :-ietworks. America Online. and St. Jude )frdical. but we lost them all for :>pecific reasons," :;ays Wall. The :-;y.-;E, he note~. Wa5 Bay ~etwork's largest customer.

• .\.s for the leading member of the "fearsome foursome," ~ficrosoft's chief financial officer, Michael W. Brown, has just been appointed chairman of :o;A.SDAQ's board of directors. [ntel's Treasurer, Arvind Sodhani, also on !llASDAQ's board,

IN THE TR£NCHES ---------------------The ~-YSE's quest for brand identity includes being an accommodating host to broadcasts from the floor

auction market with a specialist states: "We're very well served

would mean lower ;:;preads. And by !llASDAQ." Yes, he says, the

that has happened." says Case. Ac- !llYSE has made a "fairly deter-

cording to AOL's investor relations mined effort" to attract Intel, but

staff. on :-.'A.SDAQ nnly :Q)q, of trades "there's no reason to move." As

had a spread iJf one-eighth or less. for tech firms such as Bay Net-

compared to 60% on the :-<YiiE. works and Iomega that made the

Despite these high-profile defec- move, Sodhani says that "a lot

tio~, -"A.SDAQ still boasts many of the leading technology com- of those are younger firms, and they may have had their

parues. Among them are companies that have a strong sense of own reasons to want to do it."

loyalty to a market that took them on when. say. the NYSE would Wall complains that the competition is skewed because of

not. SA.SDAQ's system of multiple market makers for each stock the .'iYSE's Rule 500. That requires that !llYSE companies get

helps provide µquidity to sm:YJer companies that don't yet have a supermajority of shareholders voting approval if a com~y

a large followmg among arutfysts and need multiple dealers to wants to delist. The NYSE says the issue is a red hemng,

generate more interest in their stock. And when it comes to list~ since companies don't want to leave. Wall says the issue is not

ing fees, the price is right on !llASDAQ, where listing fees are far a red herring and that he has the letters from SYSE compa-

lower than on the N"YSE. N'ASDAQ is also the ma&er of an art that nies to prove it.

the :-IYSE is just now getting better at: self-promotion and mar- The rule helped the exchange land Concert PLC, the pro

keting. The SYSE doubled its entire advertising budget from $7 pa;ed entity that would come out of the planned merger of. ~CI

million to $14 million for 1997. but that pales next to the $2() mil- Communications, .'llASDAQ's fifth-largest company, and British

, ____ li_on_t_ha_t_:'i_A_s~_D_A_Q_has __ to_spe_n_d_o_n_n_'_ad_v_ertlSUl_· _· ..::g:_al_on_e_. ____ Te_l_eco_mm __ uru_·_ca_ti_·o_ns_. _an_NY_s_E_co_m_pan __ y._B_o_th_~_AS_~_o_A_Q_an_d_t_h_e

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particularly involved in children's charities and police organizations. "I have the ultimate respect for what (the police] do, .. he says. ""'I'he NYSE is blessed with a level of commitment from the ~ew York City police force that is extraordinary." Gras..~ worked closely with former Police Commissioner William J. Bratton, sponsoring breakfasts at the SYSE for the !-ITPD's top brass to gain management insights from the likes of Jack Welch of General Electric and Harvey GQlub of American Express. "Dick saw it as a way to support the city," says Bratton.

One criticism of Grasso that surfaces is that he is controlling. "Dissent is not

WELCOME TO THE FLOOR: Ray Jones Jr. takes a di1:e facing Grasso

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tolerated." says one funner empkiyee. Grasso finds such .assertions refiective of a much earlier time at the NYSE.

"When we have meetings, I thiDk we're a better company by the dissent.," he says. Critics also wonder whether Grasso has a broad enough vision. having worked only for the NYSE. "They've been wondering that forever," says Grasso, with a smile. "I guess they'll only know afte1' I'm gone."

For all his intensity, Grasso is not above poking fun at himself. At a dinner with 30 or so members of the trading-floor community in March. Grasso, along with the rest of the table, eyed the towering pile of salad placed in front of him. "It's embarrassing to be as tall as your meal," he deadpanned.

By Suzanne Woolley in New Yark

BUSINESS WEEK I AUGUST 4. 1997 63

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NYSE wanted Concert. and on Apr. 14 !'r'!Cl announced that Concert would join the NYSE.

Since B'T's shares are on the NYSE and .,.,ill be renamed ConC€rt, moving lrr's shares to SAS

DAQ would run up against Rule 500. In a press release. MG chief executive Bert C. Roberts Jr. $3.id that ''seeming the approval would have been inappropriate at a time when shareholder focus should be on the merits and opportunities presented by the merger." Roberts griped to SEC chairman Arthur Levitt Jr., who asked the !'IYSE to review the rule. The SYSE is reevaluating the rule and expects to have a decision by year's end.

Not only does the NYSE want NASDAQ's stars of today, it doesn't want to mi&> aM.her Intel-in-the-making. Until l!&. only three lPOS had been~ on the '.li'"YSE. Since then, over 700 companies, excluding closaHnd funds. have gone public on the NYSE. According to Securities Data C-0., the NYSE had 117 lPOS

in 1996. with proceeds of $Z3.7 billion, up from 74 lPOS with pro-ceeds of $13. 7 billion in 1995. NASDAQ had 730 !POS in 1996 with proceeds of $25.4 billion.

Tile S'YSE will soon launch an ad campaign focusing on its lPOS.

~ty control will be a key issue for the exchange when purswng more ~n~preneurial companies. "Grasso's problem is to get more listings while, at the same time, maintaining the listing requirements for those companies coming on board ... notes Perrin Long, an independent analyst of the se- ,

"' curitie~ industry. The !llYSE has modified its listing stan- / da:rds m recent years to allow companies to qualify ba.Ged on i

_ cash flow. That attracted a number of cable and broadcasting i .. companies. Previously. companies had to meet minimum I ~ ~~gs leve~ and_ have three consecutive years of proff itabdity. And m mid-1996, the exchange altered what it ; calls the .. North American standard" so that companies i could aggregate holdings in Mexico and Canada with their : U.S. operations in order to qualify for a listing. ~ Increasingly. the competition between the NYSE and NASDAQ

~ is evolving into a battle of the brands. "Every day. we wage 3 what we call a cornflakes war of brand preference," says .;: Grasso. The SYSE has greatly increased its visibility by exi panding its broadcast-center oper-Uons and allowing more ~ TV stations to set up booths above the exchange floor or to ~ broadcast from the floor itself. The SYSE also made real-time ~ stock prices available to TV stations su<ch as c~sc. CSSF!'I. and - Grupo Televisa in late 1996. About 100 live broadcasts go

6-4 BUSINESS WEEK / AUGUST 4. 1997

~-~~~~-~-~~! Not to be outdone in technology, to say nothing of stage props, NASD's Zarb and Berkeley have launched their own high-tech "market site" in New York

out from the NYSE every day, compared with fewer than 30 in 1995. One of the fastest growing items in the sYSE revenue stream is from the sale of market data. That produced $82.3 milJion in revenue in 1996, a 14% increase from 1995.

sASDAQ is countering with its own broadcast site in Manhattan-a room dominated by 100 video monitors. Much as the NYSE's trading ,fioor provides photo opportunities for newly listed companies, NASDAQ's site is a slick showplace to impress prospective or new NASDAQ companies, serve as a backdrop for broadcasts, or be used for analyst meetings. SCATTDll:D llATTl.£S. As the NYSE dukes it out with NASDAQ

for new listings, it is also waging a fierce fight to have more of the trades in those stocks executed on the NYSE. rat.her than on one of the regional exchanges. It remains to be seen bow quoting prices in sixteenths of a dollar, instead of eighths, as a step toward decimalization, will affect the war for market share. "We think our volume will go up, and that our market share will increase dramatically," says Grasso. "It will impose significant competitive pres&ll"eS on alt.ernative mal'kets." It will make it tougher to pay for order flow, he says, referring to the sale of orders to firms that pay a few cents per share for orders routed their way. If, the gap between the bid and offer on a stock shrinks from the minimum ~ gap that has been standard, that practi~ will become less lucrative-and, Grasso hopes. fewer orders will be drawn away from the NYSE.

As ~hnology breaks down the barriers to entry in securities trading, the pace o( change at the Big Board ~ have to increase. The competitive forces gathering to chip awav at its franchise are huge. Yet the NYSE has been combat~g such pressures for decades and has managed to fl~urish. Richard Grasso is quite aware of the challenges facmg his :-IYSE-and will fight like hell to maintain its momentum. As the battles continue. the real victors will be investors who get lower trading costs and better service.

By Suzanne Woolley in .Veu: fork, with lmreau reports

I I I I I I I Biodatas of

Price Waterhouse LLP

I Presenters

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W. Dennis Grubb, PRINCIPALcoNsULTANT,CAPITALMARKETs

Mr. Grobb is Principal Consultant Capital Markets for Price Waterhouse LLP. Mr. Grubb is currently based in India to administer the four year USAID Financial Institutions Reform and Expansion {FIRE) project, a collaboration between the United States and Government of India.

Mr. Grubb was recruited for this asfilgnment based on his twenty-five years of international securities and banking experience in the New York and London capital markets and his experience as a principal and partner of exchange member finns in New York and London. He has worked with Asian emerging markets in Sri Lanka, Indonesia., Singapore, Malaysia, Philippines and Larin America. Prior to coming to India in July 1995, he was a Consultant with the Asian Development Bank and served as a Director at the Merchant Bank of Sri Lanka, the country's first merchant bank.

Frank Wiison Mr. Wilson has 30 years experience in capital markets structural issues. Mr. Wilson was the Executive Vice

President. Law and RegulatOiy Policy and General Counsel of the National Association of Securities Dealers, Inc. (NASD). He managed the NASD's Legal. Regulatory Policy, Compliance, Anti-ftaud, Market Smveillance, Arbitrati~ Corporate Financing, Internal Review and Membership programs.

Since leaving the NASD, Mr. Wilson has pe.rfonned numerous international capital markets consulting assignments in Philippines, China. India, Bangladesh, Malaysia, Russia and Indonesia.

Mr. Wilson received his B.B.A. degree in Accounting and Business Administration from Upsala College :md J.D. degree from George Washington University Law School. Mr. Wilson is a Member of International, American, Federal and District of Colmnbia Bar Associations.

David Strandberg Mr. Str.mdberg is a Principal Consultant with Price W~ LLP and has been with the firm. since 1995.

Since then he has managed and co-ordinated several USAID-funded capital markets development projects in Russia and Ukraine, and, as part of the USAID-fimded Price Wateihoose team, has also recently advised the Government of Bosnia and Herz.egovina on the development of its securities markets regulatory and legislatiw framework. Prior to joining Price Waterhouse, Mr., Strandberg worked for four years in the Division of Enforcement of the U.S. Securities and Exchange Conmrission in Washington D.C. where he was responsible for a wide variety of enforcement investigations and proceedings.

Mr. Str.mdberg received.his J.D. degree from University ofMichigan Law School and A.B. degree from Duke University. He is a member of the District of Columbia and New York State Bar Associations.

Ms. Zoanne Nelson Ms. Nelson is a Principal Consultant with Price Waterhouse LLP since 1993. Ms. Nelson designs and

condncts executive training courses for enteqnise management and government officials in the CEE/NIS, Southern Africa and US. Between 1992-1994 Ms. Nelson managed USAID-fimded privatisation projects in Russia. Prior to 1992 Ms. Nelson was the Treasurer of the National Council for Soviet and East European ~ She also worked as an accountant with J.P. Morgan.

Ms. Nelson is an M.B.A, Intemational Business from The American University, Washington and B.S., Business Administration and Economics from University of Delaware.

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Price Waterhouse LLP USAID

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Participant Evaluations

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IMPLEMENTATION OF A MARKET SURVEILLANCE SYSTEM

Total Responses: 15

Question

1. Overall, to what extent are you satisfied with the workshop you have just completed?

Comments: • Excellent

August 13-14, 1997

Participant Evaluation: Results

Category/ Percentage of Respondents

Very Satisfied 93.3


Satisfied 6.6


Not Satisfied 0

• It has helped me understand the importance ofinter-Exchange co-ordination in handling emergency situations.

• • • • •

A broad idea was given The content of the workshop was elementary and the discussion was very well handled Infonriative and Useful Good to start with Was useful in development issues related to market surveillance systems

2. To what extent were the objectives of this

Very Relevant ·s6.67

Somewhat Relevant 13.33

Not Relevant 0

workshop relevant to

I your role and 1----_,_r_e_s~p_o_n_si_b_il_it_ie_s_? ________ ,__ ________________ ,__ ________________ ..__ __________________ ..._ __ -;

Comments:

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It was targeted to give an overview of the subject and to identify key elements for development in India and the objective was achieved Very useful Topics discussed were very relevant to my present responsibilities It helps in developing a model I am actively engaged in the surveillance department. This workshop has h>!lped me to determine our future direction. It will help and strengthen our basic efforts in market surveillance. Though not directly associated with surveillance functions, the (workshop) would help me in functions to be discharged by my dept. to accomplish the same objectives. Margin mechanism falls within purview of my functions. More confidence to work efficiently

To what extent were these objectives met?

To a great extent 80

Somewhat 20

Not at all 0

I C• omments:

The decisions taken at the Core Group could have been circulated in advance since we were not aware of the same (2) By listening, knowing Most of the topics discussed were correlated to the objectives of this workshop The programme could be the first step in bringing stock exchanges together in view of market surveillance. I :

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4. Which of the following discussion topics were most helpful in assisting you to better understand the

subject matter, and why?

Topic Number of Acknowledgements

Development of a Market Surveillance System 8 Overview of a Market Surveillance System 7 Discussion of Market Surveillance Activities 8 at several Indian Exchanges The Thailand Surveillance System 6 The Sri Lankan Surveillance System 7 The Role of the Regulator in Sri Lanka 4 . The Role of the Regulator in the US 5 Group Exercise and Plenary Session: Action Plan for India 8

Comments:

• Regulator in US will contribute to redefine core areas of trust

• Wide knowledge is a must for one to understand the need to implement an effective stock watch system.

• Provides a better idea of what happens in other countries

• Discussion of Market Surveillance Activities at Several Indian Exchanges was excellent

5. Which discussion topics were least effective in assisting you to understand the subject matter, and

why? (

• The Role of the Regulator in the US

• The Sri Lankan Surveillance/ Role of the Regulator in Sri Lanka as it was not directly related and/ or relevant (2)

• Discussion of Market Surveillance activities at several Indian Exchanges, since the information was

already provided through various channels; it was a duplicating effect.

• Development of a mark~t surveillance system

• The Thai Surveillance System. The presenter was not connected to operations but was an IT f

-6. Overall to what extent Completely Somewhat Not at all

do the following apply to the presenters:

a. Were well prepared 100 0 0 b. Were knowledgeable 73.3 26.6 0

about subject matter c. Presented content 86.67 13.33 0

clearly d. Were responsive to your 100 0 0

queries Comments:

• Presenters have a good and thorough approach with clarity. However an in-depth and micro aspect of the subject

could have been more useful

• Good

• More knowledge of the Indian situation is required

• I enjoyed the workshops presented by Ms. Nelson and Ms. Surekha extremely

7. What additional comments/ suggestions do you have for on-going workshops and training and development programs related to market surveillance?

• Should focus more on the uniqueness of the Indian system/ made more applicable to Indian situation (2)

• Course material should be given in advance to study before the course begins. case studies/ case

examples coupled with entire histories of the case and/ or detection of violations should be given to ensure that participants know, understand and analyse the same in detail.

• Practical training at the NASO and the NASDAQ if provided to persons actively engaged in surveillance, might be useful.

• Such a workshop should be conducted at least once a year • Is a beginning in the right direction • More examples should be quoted • Bring in personnel (experts) who are working for countries where there are multiple stock exchanges

and also where there are problems similar to Indian conditions • These must include a detailed structure and function of big exchanges • May be frequently held to understand our present position and where we need to go.

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