Or is it some combination of these two images?
Wall Street may appear to be a place where business is conducted properly, where the interests of investors are always top of mind. But there are a lot of shenanigans going on behind the scenes that we can glimpse in the financial press. And then, after reading about them, we either feel the need to take a long shower or the desire to inhale toxic tobacco fumes while drowning our sorrows at the local pub.
OK, maybe we all don't have the same reactions. But we should, from time to time, assess the crime in our streets, whether it's the hush-hush white-collar variety of Wall Street or the whatcha-gonna-do-when-they-come-for-you-bad-boy, blue-collar, "Cops" version. And, we might try to answer the question, "How bad is this crime from an ethical perspective?"
Specialists in the NYSE
Let's take a look at the allegations of improper trading among specialists at the New York Stock Exchange. First, some background about what these traders actually do.
Specialists are market makers, middlemen actually, who are assigned particular stocks in which they trade. Their purpose is to keep an orderly flow of prices on the trading floor by matching up buyers and sellers. You can see them on CNBC, yelling and screaming at the tops of their lungs. You thought that was chaos? No, that was order.
They must make trades to facilitate these transactions, and they make money in the process. Specialists profit on the spread between the bid and ask price of a security, which is the difference between its purchase and sale prices. They also get money from dividends and interest earned on the securities they own, and they realize capital appreciation from securities they sell.
These are the lawful ways that specialists can make money to fulfill their profound responsibility: They must buy and sell securities in all market conditions, and they bear the risk of loss from unexpected price drops. A textbook on investments describes their role this way: "These market makers guarantee to buy and sell at the prices they announce. Thus, an investor knows what the securities are worth at any given time and is assured that there is a place to sell current security holdings or to purchase additional securities. For this service, the market makers must be compensated. ..."
Saintly specialists
In fact, it is in the specialist's job description to trade against the grain of the market, buying when stocks are getting trashed and selling as they scale new heights, risking their capital in the process, all for the altruistic purpose of putting their brokerage customers (and ultimately you) first, above their own interests.
In other words, their actions are ostensibly selfless. These specialists should be canonized as stock market saints.
Except that they're human beings who succumb to temptation. Being privy to the imminent direction of stocks in the market puts them in a unique position to exploit that information for selfish gain. And recently they've gotten into trouble for doing just that -- more about that in a minute.
Superfluous specialists
First, let's explore their role in the scheme of things. Are they necessary parts of the market machinery or are they an encumbrance, a wrench in the works?
"NYSE floor traders can be replaced by a computer -- literally," says Gary Weiss in his book, "Wall Street Versus America: The Rampant Greed and Dishonesty that Imperil Your Investments."
"Nasdaq is a computer network," Weiss points out. "No specialists, no floor brokers, no trading floor. Most stock markets nowadays, from Tokyo to London, are like that -- all electronic."
But the NYSE maintains that the specialist system is superior to computer networks. For one thing, the frenzy of market activity can't be captured by focusing cameras on a computer network.
Says Weiss, "The NYSE and its defenders say that having people throwing papers around on a trading floor contributes measurably to the smooth flow of the markets generally, thereby justifying the existence of the specialist system and the existence of the exchange and the existence of the big building at Wall and Broad with the columns in front, and all salaries and benefits and pensions paid therein."
Weiss's book is laced with sardonic humor, provoking chortles, guffaws and at times some rather uneasy laughter.
So how did the aforementioned specialists get into trouble? Apparently some were found to have made trades that were "improperly positioned between buyers and sellers," putting their customers at a disadvantage. At the turn of the 21st century, over a period of several years, they made trades ahead of customers thousands of times, resulting in hundreds of thousands of dollars (and sometimes millions of dollars) in improper profits for their specialist firms. But get this: These illicit trades accounted for less than 1 percent of the volume of trades executed by each specialist.
Does that minimize the sin at all, from your point of view?
From the perspective of federal prosecutors, such gains are your losses. The specialist firms involved already settled the civil cases related to the trading scandal, having paid out $248 million in 2004 without admitting or denying wrongdoing. This, by the way, is the standard way that Wall Street firms handle their misdeeds. When they are called on by a government regulatory agency to right a wrong, they generally pay fines, but do not admit or deny any wrongdoing. It seems like a way to do penance while avoiding the uncomfortable moment in the confessional.
Status of specialists
So far, of the 15 indictments made a year and a half ago, charges were dropped for a couple of specialists, two were acquitted at trial and two pleaded guilty in May, receiving prison sentences of 27 months and fines of $250,000 each. In July, two specialists were convicted of securities fraud. Six cases have yet to be tried.
Most recently, in October, one specialist, whose trades were found to be more problematic than the others, was convicted of three counts of securities fraud. The prosecutor said in opening arguments that the trader "improperly positioned himself between public buy and sell orders more than 26,000 times between 1999 and 2003. As a result, the specialist made more than $4.5 million in illegal profits for his firm," according to a report in The Wall Street Journal.
The defendant's lawyer argued that the trades represented less than 1 percent of the trades executed by the specialist and that these "were simply the result of mistakes and miscommunication during a frenzied period of trading at the Big Board."
Let's see, 26,000 trades resulting from mistakes and miscommunication. Wow! That has to be a record. Though this trader potentially faces 20 years in prison, he will likely get a lighter sentence. Why? Because the presiding judge "raised questions about the government's case, saying there 'is some fuzziness in the law,'" according to a report in The Wall Street Journal. Among the judge's observations: These trades appear to be commonplace at the Big Board.
Just because it is common, does that make it OK in your book? And what about other Wall Street scandals? Are the underhanded slights against individual investors something we should just accept as part of the cost of investing in the stock market? Or is there something inherently wrong with companies making profits at the expense of unwitting investors? |
