Concentration Trends and Competition in the Securities Industry: An Alternative Viewpoint

In “Concentration Trends and Competition in the Securities Industry” (published in the November/December 1977 issue of Financial Analyst Journal) Jeffrey Schaefer and Adolphe Warner warned that elimination of off-board trading restrictions would ruin the auction market by shifting market making in listed equities from exchange specialists to the largest brokerage firms, which would then concentrate on larger, more liquid stocks and largely ignore the securities of smaller companies. In their article below, Richard West and Seha Tinic challenge the assumption that the specialist system is a necessary ingredient of a true auction market.

While Schaefer and Warner regarded specialists as essential for ensuring price continuity and liquidity, West and Tinic regard the specialist’s agency role in executing limit orders as essentially anachronistic given today’s advanced computer technology and argue that surveillance by floor governors is unnecessary in a market that fosters heightened competition. West and Tinic see alternative market systems such as those proposed by Merrill Lynch and Peake-Mendelson-Williams—neither of which restricts market-making activity to times when some regulator deems it necessary—as the real threat to today’s exchanges.

Schaefer and Warner reply that West and Tinic have misconstrued the thrust of their argument. Their major question was, “Why is the SEC pressing for repeal of off-board trading rules before a framework for a national market system has been established? Schaefer and Warner argue that Rule 390 and the specialist system continue to serve the securities markets well. Because the greatest near-term threat to the specialist system is upstairs market making by member firms, it is not surprising that the SEC ultimately concluded, as did all segments of the securities industry, that Rule 390 should not be removed until the foundation of a national market system had been laid.