Stock Exchanges Stock exchanges are formal organizations, approved and regulated by

Stock Exchanges Stock exchanges are formal organizations, approved and regulated by

the Securities and Exchange Commission (SEC). They are made up of members who use the exchange facilities and systems to exchange or trade listed stocks. These exchanges are physical locations where mem- bers assemble to trade. Stocks that are traded on an exchange are said to be listed stocks. That is, these stocks are individually approved for trading on the exchange by the exchange. To be listed, a company must apply and satisfy requirements established by the exchange for mini- mum capitalization, shareholder equity, average closing share price, and other criteria. Even after being listed, exchanges may delist a company’s stock if it no longer meets the exchange requirements.

To have the right to trade securities or make markets on an exchange floor, firms or individuals must become a member of the exchange, which is accomplished by buying a seat on the exchange. The number of seats is fixed by the exchange and the cost of a seat is deter- mined by supply and demand of those who want to sell or buy seats. In early 2001, there were 1,366 seats on the NYSE.

Two kinds of stocks are listed on the five regional stock exchanges: (1) stocks of companies that either could not qualify for listing on one of the major national exchanges or could qualify for listing but chose not to list; and (2) stocks that are also listed on one of the major national exchanges. The latter are called dually listed stocks. The moti- vation of a company for dual listing is that a local brokerage firm that purchases a membership on a regional exchange can trade their listed stocks without having to purchase a considerably more expensive mem- bership on the national stock exchange where the stock is also listed. Alternatively, a local brokerage firm could use the services of a member of a major national stock exchange to execute an order, but in this case it would have to give up part of its commission.

The regional stock exchanges compete with the NYSE for the execu- tion of smaller trades. Major national brokerage firms have in recent years routed such orders to regional exchanges because of the lower fee they charge for executing orders or better prices, as we will discuss later.

FOUNDATIONS

OTC Market The OTC market is called the market for unlisted stocks. As explained

previously, technically while there are listing requirements for exchanges, there are also listing requirements for the Nasdaq National and Small Capitalization OTC markets. Nevertheless, exchange traded stocks are called listed, and stocks traded on the OTC markets are called unlisted. There are three parts to the OTC market: two under the aegis of NASD (the Nasdaq markets) and a third market for truly unlisted stocks, the non-Nasdaq OTC markets.

The Nasdaq stock market is the flagship market of the NASD. Nasdaq is essentially a telecommunication network that links thousands of geo- graphically dispersed, market-making participants. Nasdaq is an electronic quotation system that provides price quotations to market participants on Nasdaq listed stocks. Although there is no central trading floor, Nasdaq has become an electronic “virtual trading floor.” Some 535 dealers, known as market-makers, representing some of the world’s largest securities firms, provide competing bids to buy and offers to sell Nasdaq stocks to investors.

The Nasdaq stock market has two broad tiers of securities: (1) the Nasdaq National Market and the Small Capitalization Market. News- papers contain separate sections for these two tiers of stocks (sections labeled the “Nasdaq National Market” and the “Nasdaq Small Capital- ization Market”). The Nasdaq National Market is the dominant OTC market in the United States.

Whereas the Nasdaq stock markets are the major parts of the U.S. OTC markets, the vast majority of the OTC issues (about 8,000) do not trade on either of the two Nasdaq systems. There are two types of markets for these stocks. The securities traded on these markets are not listed; that is, they have no listing requirements. The first of these two non-Nasdaq OTC markets is the OTC Bulletin Board (OTCBB), sometimes called sim- ply the Bulletin Board. It includes stocks not traded on NYSE, AMEX, or Nasdaq. The second non-Nasdaq OTC market is the Pink Sheets that are published weekly. In addition, an electronic version of the Pink Sheets is updated daily and disseminated over market data vendor terminals. Pink Sheet securities are often pejoratively called penny stocks.