NYSE system no boon to investors

By DAVID MOON, Moon Capital Management
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 And last week, mutual fund giant, Fidelity, stuck out its neck and called for an end to this outdated, rigged system.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 employers.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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