NYSE to Act Against Five Specialist Firms

On a number of occasions, the NYSE has said it's investigation has not found any evidence of front-running by specialists, a more serious offense in which inside information is used to manipulate the market.

To some, the distinction between what constitutes front-running and the negative obligation rule sounds like semantics. But front-running is a more significant fraud and potentially can generate much bigger illegal gains for a specialist.

NYSE officials, meanwhile, strongly denied reports that the Securities and Exchange Commission has opened its own investigation into allegations of front-running on the Big Board.

"We know of no investigation by the SEC into front-running," said Catherine Kinney, the NYSE's co-president and co-chief operating officer.

In fact, the Kinney and other NYSE officials said their investigation should provide comfort to investors because it found only a few cases of improper trading. Altogether, Kinney said the trades under scrutiny involved some 2 billion shares of unspecified stocks, which is equivalent to a little more than one day's worth of trading activity on the Big Board.

"The New York Stock Exchange is the best market," said Kinney.

Of course, that's a point Big Board critics dispute. Critics contend that electronic trading systems are not only faster but more objective in matching trades. Critics also contend that electronic systems produce better prices.

"All of the revenue the specialists take in is revenue that comes out of the customers' pockets," said Junius Peake, a professor at the University of Northern Colorado College of Business.

Peake also said the NYSE enforcement action could spell trouble for the specialist firms beyond whatever fines they are ordered to pay. He suggested that it could lead a class-action lawsuit, similar to the 1990s suit brought by investors against the trading firms that served as market makers on the Nasdaq Stock Market.

The Nasdaq class action, which settled for a $1 billion, involved allegations that market makers were colluding to fix prices and commissions in trading Nasdaq stocks. The class action got a big boost when securities regulators brought an enforcement action against a number of Nasdaq market makers.