Calpers Sues the NYSE - TheStreet

Calpers Sues the NYSE

It alleges the exchange's system is regularly abused. Specialist firms are also named.
Publish date:

Updated from 6:14 p.m. EST

The $138 billion California Public Employees Retirement System sued the

New York Stock Exchange

and the specialist firms that operate there on Tuesday, claiming the system by which stocks are bought and sold on the exchange is regularly abused and nothing is ever done about it.

The nation's largest pension system cited a host of supposed rule violations that it said are endemic to the Big Board, mostly involving the entrenched advantage afforded the exchange's specialist middlemen. Specialists are charged with making an orderly market in the thousands of stocks traded on the exchange through an "open outcry" auction system that sometimes requires them to buy and sell shares for their own account.

Other exchanges, including the

Nasdaq Stock Market

, use fully computerized trading systems.

"This complaint alleges the defendants, in violation of the Securities Act of 1934, employed devices, contrivances, manipulations and artifices to defraud," the complaint said. It cited "practices and a course of business that operated as a fraud or deceit to the members of the class -- financially advantaging defendants."

The suit, for which Calpers wants to be the lead plaintiff, seeks to return millions, or even billions, of dollars to investors, a statement from the system's controller's office said.

The suit is just a part of a broader effort by Calpers and other public investors to increase the pressure on the NYSE to institute meaningful reforms, said Charles Elson, a business professor at the University of Delaware who chairs the school's corporate governance center.

"What this will accomplish, we'll have to see, but it puts pressure on people to rethink the specialist system," Elson said. "Anytime a fund that large weighs in, that's significant. It puts pressure on the exchange to respond to it one way or other."

The allegations raised by Calpers are not new to the NYSE. In fact -- as

reported in October -- the exchange itself is handing out tens of millions of dollars in fines after determining five firms broke its trading rules. Calpers has recently been extremely critical of the Big Board, lambasting a plan to overhaul its governance authored by interim Chairman John Reed after agitating for the ouster of his disgraced predecessor, Richard Grasso.

The NYSE, though a spokesman, declined to comment on the suit.

Calpers is represented by another major thorn in Wall Street's side, William S. Lerach's Milberg Weiss law firm, long the most aggressive litigator in the area of shareholder activism. The complaint purports to be a class-action representing anyone who bought or sold stock on the Big Board between October 1998 and October 2003.

"The specialist firms have routinely engaged in wide-ranging manipulative, self-dealing, deceptive and misleading conduct," the plaintiffs wrote. Specifically, they cited so-called "inter-positioning" in violation of the exchange's "negative obligation" rule, which says that specialists shouldn't take positions in trades when a buyer and seller agree on their own price.

The also cited "front-running," in which the specialist middleman purportedly uses knowledge of existing orders and an understanding of how they will affect prices to make sure-thing bets prior to executing for his customers. Also cited was price "freezing," when a specialist supposedly stops updating public stock prices in a stock to allow either of the above abuses.

"Through the class period, defendants misrepresented that the specialist firms were substantially complying with the NYSE's rules and the exchange act, and that the NYSE was effectively overseeing its members," the complaint alleges.

"The NYSE's deliberate failure to oversee, regulate or supervise its securities exchange or discipline its members/specialists for their blatant violation of the NYSE's rules was a key part of the defendants fraudulent scheme and course of business," the suit reads. "The NYSE knew that its specialists were repeatedly violating the Exchange Act and the NYSE's own rules, yet the NYSE deliberately failed to halt, expose or discipline the illegal trading practices to the extent necessary to deter, stop or prevent them."

Specialist proponents argue the presence of people provides a safety net in times of extreme market volatility. They say the system is the best for the majority of investors, even if some heavy-trading institutions say otherwise.

The major specialists working on the Big Board, all of which were named in the complaint, are

Van Der Moolen





, a division of

FleetBoston Financial



Goldman Sachs'

(GS) - Get Report

Speer Leeds & Kellogg unit, and Bear Wagner, which is partially owned by

Bear Stearns


, Susquehanna Specialists and Performance Specialist Group.

While interim chairman Reed quickly moved to reform the exchange's governance system, breaking up the old board who signed off on Grasso's exorbitant pay package, he has said little to suggest the specialist system will be changed. But even the board overhaul was criticized by Calpers when it was announced in November; the pension system said investors needed a bigger role on the NYSE board.

Calpers president Sean Harrigan said the pension fund filed the complaint Tuesday -- the last day it could to get lead plaintiff status in a class-action suit -- because it was unhappy with the results of a

Securities and Exchange Commission

investigation into specialist system abuses.

He called the NYSE's past punishments of specialist firms "a slap on the hand."

"I think there was a tacit agreement on the part of the exchange to look the other way," he told CNBC today.

He said reforms to the system were inadequate, but did not call for an end to the specialist system. "It's just fraught with problems, and the problems need to be addressed," he said. "I happen to believe that the Nasdaq system works more efficiently."

Goldman Sachs, LaBranche and Performance Specialist Group all declined to comment on the suit. Todd Silverberg, general counsel for Susquehanna, said he believed there was no factual basis for his firm's inclusion in the lawsuit.

"While we understand that the NYSE and the SEC are conducting investigations into improper activities by NYSE specialists, neither the NYSE nor the SEC have alleged any improper conduct on our part," Silverberg said.

"We have not been named in any other lawsuits regarding this matter. Moreover, none of our employees have ever served as a director of the exchange. We believe that there is no factual foundation for our inclusion in this lawsuit other than that we are a specialist on the NYSE," he said.

Although Calpers has taken the lead in governance issues lately, it generally hasn't acted alone. In fact, Harrigan and California State Treasurer Paul Angelides are founding members of a nascent coalition of public pension fund managers that has acted in concert on efforts such as demanding Grasso's resignation and

pushing the SEC to liberalize proxy access rules.

But in filing its lawsuit Calpers is acting without its frequent partners. In fact, one of its erstwhile allies, North Carolina State Treasurer Richard Moore, has gone in the opposite direction, agreeing earlier this month to join the executive board of the NYSE.

Representatives for Moore, New York State Comptroller Alan Hevesi, another of the founding members of the pension funds' National Coalition for Corporate Reform, declined to comment on the lawsuit.

Staff reporter Troy Wolverton contributed to this story.