By DAVID MOON, Moon Capital
October 19, 2003
In the midst of fury about the pay of the former head of the NYSE, few people
focused on the most important issue in the debate surrounding the activities at
the corner of Broad and Wall streets. Why do we have a large room (several
rooms, actually) of people running around buying and selling stocks - sometimes
for their clients, sometimes for themselves? Isn't there a more efficient
and effective way to transaction billions of dollars of trades each day?
Yes, there is. And last week, mutual fund giant, Fidelity, stuck out
its neck and called for an end to this outdated, rigged system.
Plenty of defenders will be quick to claim advantages of the NYSE system,
especially compared to the computer-based network of trading offered by the
NASDAQ and other small trading platforms. But consider this: when you
place a trade on the NYSE, your buy or sell order is ultimately filled by
someone who knows all of the immediate potential buyers and sellers of that
stock. In fact, the person who fills that order himself is a potential
buyer or seller, depending on the circumstances. These market specialists
are in a position both to match orders between buyers and sellers - and to be a
buyer or seller themselves. This is a system that ultimately relies on
trust. But you have to trust a person you don't even know, and for most
investors, don't even know exists. And that person has a huge, natural,
unsupervised incentive to place his interest about yours.
It is not the type of system anyone would devise if starting from scratch
today. No one except the specialists, anyway.
NYSE defenders, laughingly call these specialists public servants, willing to
buy or sell when no one else will. But if these willing servants are
taking trades no one else wants, how do they earn millions of dollars each
year? If specialists only bought stocks when everyone else was selling,
common sense suggests they would lose money. But this system isn't based
on common sense.
With such a focus on whether you pay nine dollars a trade or $29, investors
can lose sight of the highest cost associated with the buying and selling of a
stock: the hidden cost. If given the choice, an informed investor would
likely chose to pay a penny or two more per share in commission, in order to
save 12 or 25 cents on the purchase price of a particular stock. In many
cases, however, when you hit the "submit" button on that online trading account,
you have no idea if your 'Big Board' stock purchase is ultimately filled against
a willing seller or a specialist who stands between you and the sellers.
Despite the numerous studies cited by defenders of the status quo, the
difference is not insignificant.
As former NYSE chairman, Richard Grasso, was as employee of the people who
own the NYSE, including the specialists. There is only one reason to pay
an employee $140 million. He must have earned more for his
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).