Although the NYSE's long-standing policy is to not comment while a regulatory matter is in progress, we are making an exception in connection with a current review of trading at several specialist firms. This investigation has generated substantial erroneous reporting and speculation in the media, led by The Wall Street Journal. As always, if the matter proceeds, the NYSE will disclose if disciplinary actions are taken. In the interim, in order to set the record straight and prevent misinformation from being repeated so frequently that it appears to be factual, the NYSE provides the following facts about the investigation:
The current investigation does not focus on front-running, contrary to what has been reported numerous times in the Journal, in the Journal's reports on CNBC, and elsewhere. In fact, the investigation focuses on possible violations of the specialist's "negative obligation." This is the requirement to provide an opportunity for public orders to be executed against each other within the current market and without undue dealer intervention. In other words, the specialist must "stand out of the way" when a natural match can occur between buyer and seller. Front-running is trading for one's own account with knowledge of an order or orders that will materially impact the price of a stock. The activity under investigation by the NYSE is not front-running.
The Journal reported that the probe was started by investor complaints or by specialist firms failing NYSE audits; neither is correct. No firms failed an examination, and in fact, the NYSE does not conduct audits. The investigation was initiated by an NYSE Market Surveillance analyst who was suspicious of trading in an individual stock. Market Surveillance then began an aggressive program surveilling for similar trading practices in other stocks.
To cite a hypothetical example of the practice being examined: In very liquid stocks, market orders typically begin queuing for a period of seconds while a specialist is electronically reporting completed trades to the tape. If market orders are received on both sides of the market during this period, the specialist is required to pair these orders. If the stock is bid for $25.00 and offered at $25.01, the specialist is obligated to pair market orders at $25.00 or $25.01. If, instead, the specialist executes all of the orders that could have been paired at the quoted prices -- buying from the sellers at $25.00, and then selling to buyers at $25.01 -- he or she is in violation of NYSE rules. While this is a standard practice in dealer markets, it is prohibited in the NYSE auction market.
We emphasize that at this time no one has been charged with any violations and nothing is proven, and that the investigation is ongoing. Nor is there certainty that there was improper activity in all stocks currently being reviewed. This is not to diminish the seriousness of the alleged violations, however. NYSE Chairman and Chief Executive Officer Dick Grasso has said in recent interviews that a single instance of wrongdoing is one too many.
