Here is a partial quote from a Wall Street Journal article, edited to meet the 1000 word limit.
If you have had a similar experience you may want to write to the two WSJ reporters who give their email addresses at the bottom of the article.
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NYSE's 'Specialist' Probe Puts Precious Asset at Risk: Trust
A trader for American Century, a big mutual-fund company, was outraged last month when he tried unsuccessfully to buy stock on the floor of the New York Stock Exchange. John Wheeler, the trader, says he called a Big Board hotline to complain that the "specialist" -- the floor trader who matches buyers and sellers of the stock -- hadn't filled his order, and the stock had risen in the meantime.
Within an hour, Mr. Wheeler says, an official from the specialist firm called back to say the firm had erred. And the next day he got another call, he says, from a surprising source: Richard Grasso, the NYSE's chairman and chief executive. Mr. Wheeler says Mr. Grasso apologized and told him the incident "was embarrassing, it shouldn't happen, and they would take measures to make sure it didn't happen again."
Note: would be nice to get that kind of service!
Heart of the System
The specialist is at the heart of the system, and it sets the NYSE apart from all other markets. If there is an imbalance between buyers and sellers, the specialist steps in to fill it, buying shares for his firm's own account or selling out of the firm's inventory. Many regulations govern that "principal" trading to ensure it does not hurt public investors. In return for meeting these obligations, the specialist is allowed wide knowledge of how much buying pressure and how much selling pressure there is, an immensely profitable advantage.
Critics have long complained that specialists sometimes take advantage of their position to make huge profits at public investors' expense. "Everybody who does what I do feels like it's basically a stacked deck down there," says James Malles, the head of U.S. equity trading at UBS Global Asset Management. "There's an inherent conflict: The specialists have to provide a fair and orderly market but they can trade for their proprietary account. Those are clearly in conflict with each other."
Such criticism has led to countless predictions that the stock exchange, with its reliance on a physical floor to bring traders together, would one day be made obsolete by faster, cheaper electronic markets. Those predictions reached a peak with the 1990s bull market as the technology-rich Nasdaq Stock Market's volume and glamour appeared to eclipse the stodgy NYSE. Young entrepreneurs introduced electronic communications networks, or ECNs, that traded stocks electronically without human intervention. The hope was to siphon off the NYSE's volume.
But ECNs had difficulty reaching the critical mass of trading volume they needed. Unless they had lots of volume, big traders wouldn't be confident of getting the best possible price on them. At the same time, without those big traders, reaching that volume was difficult.
The Big Board investigation has been under way for at least four months, according to several specialists. The NYSE's surveillance department audits all the specialist firms randomly each year, looking at things such as trading records, compliance, supervision and capital. Last year, some firms failed their annual audits, according to these specialists. Mr. Grasso urged an industrywide sweep and the exchange launched a more thorough investigation of each firm. The NYSE sent letters out to the major firms requesting documents on specific stocks and traders.
Mr. Wheeler at American Century recalls a panel discussion of institutional traders and specialists earlier this year where he complained of this behavior. David Finnerty, who handles the stock of General Electric Co. for Fleet Specialist, a unit of FleetBoston Financial Corp., replied: "What the specialists do is capitalism at work." FleetBoston put Mr. Finnerty on administrative leave earlier this week amid the current investigation. Mr. Finnerty couldn't be reached for comment.
Consider the beef of St.-John Dinsmore, a day trader with Momentum Securities, a division of E*Trade Group. He estimates that he lost nearly $150,000 on June 21, 2002 -- trading through a Big Board electronic system where specialists help with orders -- in the stock of International Rectifier Corp. Mr. Dinsmore says he placed a number of buy orders starting at $27.50 and while approximately 50,000 shares were purchased at $28, a full two minutes passed before the remaining buy orders, about 80,000 shares, went through at approximately $30. As Mr. Dinsmore watched the stock rise, he tried desperately to cancel the orders, but failed.
In a letter of complaint to the NYSE, Momentum Securities said this price discrepancy "gives the impression that orders were being accumulated over a significant period of time and then executed at prices that did not seem appropriate."
In a response to Momentum's complaint, the exchange said that, in the absence of sufficient "sell" orders from the public to fill Mr. Dinsmore's order, the specialist had to sell a significant volume of its own stock. It was only after that, says the exchange, that other sellers entered the market.
But Mr. Dinsmore argues that it is nearly impossible to believe that there were no sellers of the stock between $28 and $30, when minutes after the specialist sold his stock at a profit to fill his order there were sellers for the stock at $28.81, according to trading records.
Transformation
The complaints about specialists partly stem from a transformation in how these trading firms do business. A decade and a half ago, there were more than 50 specialist firms, mostly family-owned. They derived the bulk of their revenue from commissions for matching buyers and sellers, rather than principal trading -- buying and selling for their own account, and attempting to profit on the difference. But since then, mergers have reduced the number of firms to seven, and the largest are all either public firms or parts of public firms with a greater emphasis on profit.
Furthermore, the Big Board's efforts to resist competitive inroads from competing exchanges have led it to abolish commissions for many small trades. It also introduced "electronic-order matching," which allowed investors to bypass specialists. The specialist once benefited from exclusive knowledge of all the buy and sell orders other than the best-priced that there were in a given stock. Last year, the stock exchange opened up that "book" to anyone on the Internet.
Finally the introduction of decimals has vastly increased the number of potential trading points in a given stock. This has all led specialists to trade far more, and more aggressively.
In 2001, specialists bought or sold for their own account in 32% of all Big Board transactions, compared with 18% of such principal trades in 1996. In the remainder, buyer and seller traded directly with each other with no participation by the specialist.
This trading activity hasn't saved specialists from the ravages of the bear market. Although trading volume at the NYSE has held up much better than that on the Nasdaq, at 1.3 billion shares a day, the introduction of decimals has narrowed considerably the difference between bid and ask prices. That spread helps determine how profitably a specialist can trade. Specialists' after-tax return on capital fell to 9% last year from 26% in 2000.
Specialists remain among the most profitable business on Wall Street. Last year, LaBranche & Co., one of the largest firms, had a pretax profit margin on its specialist activities of a lofty 56%. Still, the company caught analysts and investors off-guard earlier this month when it announced it would miss earnings estimates by nearly 20 cents a share. On Wednesday, the firm said its first-quarter net income was $4.4 million, or seven cents a share, down about 80% from $25.6 million, or 43 cents a share, a year earlier.
Write to Greg Ip and Susanne Craig at
greg.ip@wsj.com and
susanne.craig@wsj.com
