Future of NYSE Specialists Is Gloomy

The criminal charges brought against 15 New York Stock Exchange specialists this week is an indication that they're likely to face rough weather going forward, according to the Wall Street Journal.

The U.S. government charged the NYSE specialists with fraud in the biggest crackdown on illegal trading at the Big Board, saying they manipulated orders for four years to pocket $19 million for their firms at the expense of the general public.

The charges follow a settlement last year between seven specialist firms and the Securities and Exchange Commission. Without admitting or denying wrongdoing, the firms agreed to pay $247 million, or about two-thirds of their after-tax profits since 2002. Now, questions loom large over whether the NYSE's efforts to move to an electronic trading system will signal an end to the important role that specialists have played on the its trading floor.

Specialists "have some tough times ahead," said Nhan Bui, head of stock trading at First Quadrant LP, an institutional money manager in Pasadena, Calif. "The distrust is there1/4and people will shy away from the NYSE and look to alternative trading systems," she told the WSJ.

Last week, LaBranche & Co., the largest publicly traded specialist firm, cut its outlook for first-quarter earnings, citing, in part, unfavorable market conditions.

One concern for specialists has been the growing trend of investors who package their orders in ways that specialists find harder to execute. For example, there has been a sharp increase in program trading, or the buying or selling of baskets of at least 15 stocks with a total value of $1 million or more, according to the NYSE.

Such trades often come into the NYSE's system electronically, making it more difficult for specialists to trade profitably against these orders, said Richard Repetto, an analyst at Sandler O'Neill & Partners. LaBranche cited increased program trading as one reason for its disappointing outlook last week.

A similar problem exists for specialists dealing with the increasing number of small orders on the NYSE, which involves large institutional investors breaking up their orders into hard-to-read pieces out of fear that specialists and others trading will profit from any knowledge of their plans.

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.