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'Specialist' Traders to Be Fined by NYSE

The brokers are accused of cutting in front of customers. Critics see basic flaws in the system.

October 17, 2003|Josh Friedman and Tom Petruno | Times Staff Writers

The New York Stock Exchange, already reeling from scandals over its governance and executive pay, said Thursday that it planned to fine and punish five "specialist" firms over improper trading that may have cost investors millions of dollars.

The announcement was another blow to the image of the 211-year-old exchange, long considered the symbol of American capitalism.

The alleged violations by specialists -- brokers on the NYSE floor who are supposed to match buy and sell orders and ensure smooth trading of shares -- could make it more difficult for the exchange to fight off angry reformers who argue that the floor trading system is antiquated and open to abuse.

After a nine-month investigation covering 2000 through 2002, the Big Board found that the specialists in some instances stepped in front of customers to make quick profits with their own trades.

Investors were deprived of getting the best prices available, the NYSE said. It promised to seek "substantial fines" and reimbursement of investor losses and said it would put in new surveillance software "to deter similar conduct in the future."

But critics said the case highlighted inherent flaws in the specialist system.

"All this does is add credence to the argument for reform," said John Wheeler, senior trader at American Century mutual funds in Kansas City, Mo.

Some critics renewed calls to separate the NYSE's market and regulatory functions as a way to ensure investors that they are getting a fair shake. But in congressional testimony Thursday, the exchange's interim chairman, John S. Reed, remained opposed to a formal split.

Reed took over last month from Richard Grasso, who was forced to resign by a wave of outrage over his previously undisclosed pay package, totaling nearly $188 million. Reed plans to revamp the NYSE's governance and make its operations more transparent to the public.

Yet the exchange, in its announcement Thursday, did not name the firms under investigation -- an omission that some critics said could add to the NYSE's image as a secretive organization. The NYSE said its probe "is not yet complete."

Published reports said the NYSE had targeted LaBranche & Co., the largest specialist firm; Spear, Leeds & Kellogg, a unit of Goldman Sachs & Co.; Bear Wagner, partly owned by Bear Stearns Cos.; Fleet Specialists, a unit of FleetBoston Financial Corp.; and Amsterdam-based Van der Moolen Holdings' specialist unit.

The New York Times said the NYSE planned to fine the firms a total of $150 million. Another report said the abusive trades in all cost investors more than $100 million. Reed said the fine estimate was "in the ballpark."

At a news conference, NYSE Co-President Catherine Kinney said the investigation involved trading in 2 billion shares, or about one day's typical volume.

The NYSE previously had disclosed that it was investigating its specialists. On Thursday, the five firms named in published reports were reluctant to comment, but some hinted that the NYSE was exaggerating the extent of any abuses or wrongly assuming malicious intent.

"It's possible there have been some discrepancies in trading, but we shouldn't assume the intention was to hurt a customer," said LaBranche spokesman Brian Maddox. "The trading process is intricate, and there is a lot of volume flowing through."

LaBranche said its internal review indicated that the volume of trades in question was "substantially less" than the NYSE had discussed in two recent meetings with the company.

A Goldman Sachs spokesman declined to comment other than to say the firm wanted "some clarity, some information, some data from the NYSE."

At FleetBoston, spokesman James Mahoney said, "We have not had an opportunity to review the NYSE's analysis." A Bear Stearns spokesman also declined to comment, and a receptionist at Van der Moolen said executives were unavailable.

Shares of LaBranche and Van der Moolen were pounded in Thursday's NYSE trading. LaBranche sank $1.29 to $11.26, Van der Moolen slid $1.56 to $9.05, Bear Stearns lost $1.05 to $77.26, and Goldman Sachs lost 76 cents to $87.99, but FleetBoston rose 33 cents to $32.85.

The NYSE's announcement came on a day when a House subcommittee was holding a hearing on the structure of U.S. markets, providing a forum for critics of the exchange.

Witnesses included Jerry Putnam, chief executive of Chicago-based Archipelago Exchange, one of the leading all-electronic markets challenging the NYSE for stock trading volume. The NYSE's rivals have long argued that the specialist system benefits from anti-competitive rules favoring the exchange.

For example, the Securities and Exchange Commission's so-called trade-through rule requires traders to send stock orders to the market quoting the best price, which often is the NYSE. While that would appear to be in investors' best interest, many big investors have argued that there are times when getting an order executed quickly is more important than getting the absolute best price.

"In today's electronic world, [the trade-through rule] limits customer choice and dumbs down 'best execution' to the lowest common denominator of the slowest markets, which often consist of conflicted specialists who use 'trade-through' to their profitable advantage," Putnam told Congress.

American Century's Wheeler said he doubted that the typical investor cared as much about Grasso's pay as about "what happens with his 2,000-share order when it hits the trading floor. He doesn't want someone stepping in front of him and taking advantage."

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