Rising Attack on Stock Exchange Insiders

THE well-publicized clobbering that Wall Street's professionals have taken during this year's slump has hit nobody more than the men who make the markets on the stock exchange floors --the specialists. Estimates of the losses absorbed by the 470 specialists on the New York and American stock exchanges run to tens of millions of dollars. That is not surprising, considering the seemingly thankless job that these insiders have. They are supposed to buy when most investors are selling, and sell when most are buying.

Now insult has been added to financial injury: the specialists are under widespread attack. The Securities and Exchange Commission is again examining them, as part of its broader study of the market, and even New York Stock Exchange President Robert Haack concedes: "The specialist system has its shortcomings." As if that were not enough, Richard Ney, a onetime movie actor turned investment adviser, has condemned the specialists in his sensationalist bestseller, The Wall Street Jungle. He charges that the specialists manipulate the market and more than make up their short-term losses by turning enormous profits when prices rise, as they eventually do. Most Wall Streeters find Ney's indictment grossly overstated, though few disagree with his underlying premise that the specialist system is flawed.

The system is hardly modern. According to Wall Street lore, it began by accident in 1875, when a broker named Boyd fractured his leg. Unable to move around the exchange floor, Boyd stood in place near the post where Western Union shares were traded; soon other brokers began using him to handle their buying and selling in Western Union. Instead of milling around the post until they found other brokers ready to trade Western Union, they left their orders with Boyd and moved on to the next transaction. The system spread, and today there are specialists in all listed issues. Stock markets in Canada and Japan, among other countries, do not have specialists, but the chaotic trading that prevails in those places is evidence that specialists can be valuable.

When a broker cannot readily find a buyer for a stock that he wants to sell, the specialist in that issue is supposed to buy it, thus preventing the price from caving in. When demand for the stock becomes strong, the specialist is supposed to sell it. Trouble is, the exchanges do not require a specialist to keep a stock from moving widely up or down. As the generally worded constitution of the New York Stock Exchange puts it, he must merely help moderate the price changes between each transaction "insofar as reasonably practicable."

Conflict of Interest. Many floor brokers, mutual-fund traders and major brokerage firms criticize the system. For one thing, there is a potential conflict of interest because the specialist plays a dual role. He is both a broker for other brokers and a dealer for his own account. Though the specialist risks his own money, he stands to profit from his inside knowledge of the shifting demands for stock and from his commission on trades. As a broker, he is supposed to get the best price for other brokers, even if that means losing on his inventory of stock. But it would take a saintly soul to do that all the time. If the specialist has a large interest in a stock, his instinct is to keep its price up; if he is short on the stock, he may be tempted to let it go down. Many specialists have taken a licking in 1970, when selling pressures have been enormous, but they did well in other years. Six-figure incomes are the rule.

Lack of Capital. Another complaint is that some specialists "walk away from the market" and fail to keep stock prices from gyrating sharply. The specialists argue that the current market did not fall in wild, panicky drops, as some bears had expected during the glum days last spring. But there were some sharp breaks in individual stocks. In a special report made after the assassination of President Kennedy, the SEC severely criticized the specialists for failing to support the market during that difficult time.

Some specialists do not have enough money to buy all the stock that they must in order to keep the market orderly. In an effort to buttress the capital of the specialists, the Big Board within the past five years has forced them to merge into units--a minimum of three men each. These units have from $2,000,000 to $50 million of their own money to work with. They are also allowed to buy stock at 25% margin, compared with the 65% demanded of all other investors. Even those sizable funds may not be enough to cope with the huge institutional trades in today's market. A specialist's capital may be completely tied up on days when he is inundated by several 100,000-share blocks. No specialist unit has gone broke during the bear market that dates from December 1968, but several have had to take in partners from brokerage firms to shore up their capital. Benton & Co.'s eight partners, who are specialists for U.S. Steel, Royal Dutch, Raytheon and 28 other issues, recently considered drawing straws to see who would sell his exchange seat to raise money.

Partly because of inadequate performance by some specialists, the mutual funds and other institutions often avoid doing business on the exchanges. Instead, the institutions have begun to trade through well-capitalized brokerage firms that concentrate on handling big blocks. While most of these firms are exchange members, some are threatening to quit and take their business with them unless the specialists provide better service. In addition, quite a few brokerages do not trade on the exchange at all, but deal directly with big customers. If the exchanges are to continue to be the primary stock markets, they must fight this competition.

The Closed Club. The faults of the specialists stem largely from the fact that they operate as a private, loosely restricted club. Any well-heeled exchange member can theoretically become a specialist, but all the listed issues are already assigned to the relatively few specialists. On the New York Stock Exchange, newly listed issues are allocated by a 17-man committee; of its members, six are specialists, and the rest figure to be allied with them by friendship or self-interest.

The exchanges have only rarely taken a stock away from any specialist. Since specialists enjoy a monopoly position, some tend to become slothful. The floor brokers who deal with them gossip about those who, out of timidity or cupidity, have failed to perform well. If the specialist system were not so politically controlled, the exchanges might consider dismissing a few specialists. In addition, the exchanges might do well to permit floor brokers to vote secretly every year on which specialists to drop from the club.

At the very least, the specialists ought to have more capital and more competition among themselves. Bringing more bright young members into the tight old club could serve both purposes. One way to improve the system would be to assign at least two specialists to each stock, thus increasing the capital available to stabilize the issue and introducing a measure of competition.

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