Specialist Trading Practices
This is another illustration of how the
specialist system works against the average
investor. On Thursday April 17th 2003, the
following news story came across the
Reuters News Service. In part the article
was as follows:
NYSE Probing Specialists Trading
Practices:
A report published on Thursday in the Wall
Street Journal said that, according to
people familiar with the matter, the NYSE
was investigating whether at least two of its
largest specialist firms may have engaged
in trading shares ahead of clients in a
possible abuse of the exchanges trading
system.
The report said that the exchange was
examining whether the specialist firms, who
manage the buying and selling of shares on
the floor of the exchange, had offered
inferior prices to investors who send orders
to buy and sell shares through the
exchanges main trading system.
The exchange has run its auction model of
trading stocks, which is mediated by
specialists, since it’s founding in 1792.
Specialists have an obligation to maintain a
“Fair And Orderly Market”, which at times
forces them to use their own capital and
make unprofitable trades to match buy and
sell orders.
The temptation to do “Front-running” has
risen as volume has fallen sharply. When
“front-running” a trader places their own
orders for stocks before carrying out
customer’s orders.
Institutional investors, such as large mutual
fund companies, have complained for years
that improper trading by specialists has cost
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their investors huge sums of money. Market
experts say individual investors attempting
to buy and sell shares through the NYSE’s
auction system, in which a human being
rather than a computer matches buyers and
sellers, also can be hurt by front running.
Essentially the abuse of power works like
this: An individual investor wants to buy
shares in Company A at $30.00. The
investors brokerage firm transmits the order
to the floor broker at the exchange. The
broker takes the order to the specialists
booth where he conducts his trades in
Company A’s stock.
The specialist is supposed to match the
investor’s buy order to a sell order at the
best possible price. Illegal front-running
occurs when the specialist uses his
knowledge of the pending $30.00 buy order
to buy shares for his own investment
account, knowing the stock he is buying will
go up.
After buying the stock for himself at $30.00,
the specialist then executes the individual
investors order, but at a higher price,
perhaps at $30.10. The specialist sells him
the shares he has purchased and takes
advantage of the increase in price caused
by the buy order. While individual
instances of front-running may only
account for only a few hundred trades a
day, front running profits can add up
quickly in a market that trades over two
billion shares a day.
The Securities and Exchange Commission
was ordered by Congress in 1962 to
conduct an investigation of the NYSE to
determine what role it played in the market
crash of that year. When the staff issued its
findings in 1963 it was clear that the staff
recognized the inherent conflicts of interest
in the specialists dual functions.

In its report the commission stated that,

quote “purchases made on the exchange
by specialists for the purposes of
segregation into long term investment
accounts raised problems that go to the
heart of the specialist system”. The report
goes on to say and I quote, “The heart of
the problem with the stock exchange is
the specialist. If there is to be any reform
of the market it should be with the
specialist”.

Unfortunately since that report was issued

none of the rules that were established in it
were ever enforced. This is why 85 percent
of investors never make any consistent
money in the market and become frustrated
with it, and they leave never to return

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