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April 30, 2003

NYSE Scandal May Be Over the Top

By Gregory Bresiger

The dollar amounts that may have been skimmed off by some specialists in the front-running style scandal at the New York Stock Exchange could come as the biggest shock, according to one well-informed pro.

As the Big Board and the Securities and Exchange Commission continued their probe into the reported trading abuses - abuses in which traders sometimes profit by trading in advance of their own customers' executions - one buyside trader said the final story may be anticlimatic.

"Is it a full-fledged scandal? I'm not sure. Not in the way that Worldcom or Enron were scandals," said the buyside trader. "If specialists profited, they didn't make tens of millions of dollars doing it," continued this trader, who works for a large institutional investor. He declined to be quoted by name. "I'd guess that the profits will prove to be modest. Someone will certainly try to write a small investors got rooked story, but it's going to be a stretch."

Still, other pros argue that the full extent of the alleged wrongdoing should not be underestimated. Many institutional trading managers, such as John Wheeler at American Century, have been outspoken about reputed practices on the NYSE, practices which include front running and penny jumping.

One pro, in an interview with Traders Magazine, challenged recent published numbers from the Big Board. Specialists acted as a buyer or seller in some 30 percent of shares traded in 2001, according to these numbers. "Are you kiddin?" said this upstairs trader. "How convenient. I'd wager the specialists are participating in 60 to 70 percent or maybe even more of all shares traded at this point."

The scandal has brought more unwanted publicity on the Big Board, following a succession of recent black eyes involving botched nominations and regulatory run-ins. This latest scandal broke when the Wall Street Journal reported that some specialist firms were the focus of an NYSE investigation into the mishandling of customer orders. The probe is also likely to examine whether orders were improperly handled on the NYSE's DOT system.

The Big Board took what might be an unprecedented step and issued a statement. "While exchange policy precludes us from commenting on regulatory matters," said Ray Pellechia, an NYSE spokesman, "the NYSE does confirm that, as part of its ongoing commitment to surveilling the marketplace, it is conducting a review of trading practices at several specialist firms." The exchange later described some media reports of NYSE front running as inaccurate. The Wall Street Journal defended its own reporting. Meanwhile, NYSE chairman Dick Grasso promised prosecution if wrongdoing is found on the exchange.

How extensive is the NYSE probe? The buyside trader told Traders Magazine that the investigation is covering several firms and is looking at several different trading issues, including trade reporting and the freezing of books.

"Specialists have been complaining that the large number of small trades overwhelms them and forces them to freeze the book," said the buyside trader. "That is probably hurting the small investor," he added. The trader also said that many of the specialists are complaining they have to "freeze the book" to catch up in heavy volume traffic. "The exchange and my guys seem to think that if specialists paired off everything possible, they wouldn't be overwhelmed. They're crying wolf and profiting from it at the same time," he said. He added that front running is caused, in part, because decimalization has narrowed spreads and made the market a better place for the individual investor. And he predicts that "the probe will change the NYSE dramatically."

-with John A. Byrne