Specialists stumble

The New York Stock Exchange

Apr 14th 2005
From The Economist print edition

Charges against its middlemen roil the Big Board

LOTS of money can be made in the tiny gaps between the buying and selling prices of shares. But the “specialists” on the New York Stock Exchange (NYSE), who match buy and sell orders, walk a fine line between their duty to their customers and that to their employers. Too fine, it seems. This week federal prosecutors in America charged 15 specialists with making $19m for their firms from improper trading. At the same time the Securities and Exchange Commission (SEC) settled civil charges against the NYSE for poor oversight of its floor, where most trades are still done.

The SEC also brought civil charges against 20 specialists (including those criminally charged) for “pervasive” fraudulent trading between 1999 and 2003. The reason, says the commission, was that the specialists traded for their own accounts when they should have been filling customers' orders first. (Specialists are allowed under certain circumstances to buy and sell stocks for their firm; this helps keep the market moving if liquidity is low.) For example, when a buy order comes in at a higher price than a sell order, the specialist's duty is to match the customers rather than profit from the spread. The SEC says that some such practices went awry—and also that the specialists sometimes abused their positions by trading in advance of customer orders.
The specialist firms—which include elite names such as Bear Wagner and Spear, Leeds & Kellogg (a Goldman Sachs subsidiary)—have been braced for this blow. Last year the companies settled with the SEC for over $240m. One of them, a Dutch firm called Van der Moolen, has seven ex-traders facing charges this week.

For the NYSE, it is another black mark for its efforts at self-regulation, though its standards have been toughened since 2003. The exchange got into trouble with the SEC in 1999, when it was charged with failing to stop illegal trading schemes perpetrated by groups of floor brokers. As part of this week's settlement, in which the Big Board, as in 1999, neither admitted nor denied charges, the NYSE is due to pay $20m to buttress supervision of its regulatory system. It must also begin pilot video and audio surveillance of floor trading of certain highly liquid stocks.

This week's charges may hasten the exchange's switch away from the floor. “Electronic trading systems are much less scandal-prone,” says Benn Steil of the Council on Foreign Relations. The NYSE already plans to become more electronic—and, says Mr Steil, if John Thain, the chief executive, and Marshall Carter, just appointed as chairman, want to get serious about an initial public offering, the trading floor might just have to go altogether. Specialists would rue that day, but would have only themselves to blame.

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