As you are aware, the specialist's prime job responsibility is to provide a liquidity function to the markets. He can perform this function by finding interests to take the other side of the transaction, by setting the opening price that would facilitate others traders to take the other side of the trade, or the specialist can step in and take the other side of the trade themselves. Even when they need to enter to provide liquidity during a sell off for example, the specialist still gets to choose where they will enter their trades. As you know, the specialists other job functions include managing stop and limit orders through the "order book", managing the SuperDOT executions against the stock he is responsible for overseeing, handling the impact of unforeseen news items with respect to the illiquidity that can be created by choosing to stop trading on the stock and deciding when to reopen it and selecting the price the stock will reopen at, and the normal opening and closing the stock, which includes choosing the opening price of the stock at the beginning of the trading day.
Yes, the specialist's role with their "order book" does place them at an advantageous position with respect to the other traders in the stock which the specialist can take advantage of. For instance they can trade on their personal account with this information. I want to note here this same information is available in the form of a "picture" that can be requested from the specialist by a floor trader. The specialists also receives payment for each share transacted on each stock within their oversight which is another unique advantage to the specialist.
The above listed advantages the role of specialist has to offer is different than "controlling" the price of a stock as some seem to think the specialist is able to do. The open outcry system IMO leads to more fair pricing and since business is conducted out in the open, there is less opportunity in this system for price rigging by the specialist or other special interest. This arrangement also facilitates the honoring of quotes unlike its NASDAQ counterpart. Not only is the specialist just a facilitator in 70% of the transactions that occur on a liquid stock, but they also do not work customer orders, and they do not provide payment for order flow like the MM of NASDAQ does. Still, for a specialist on the listed exchange, an inventory accumulated in their professional and personal accounts may place them in a position where there is a potential conflict of interest involved which I am sure some have taken advantage of particularly with respect to the more illiquid stocks.
This approach used by the listed exchanges IMO is much more fair to the outside trader than that of NASDAQ. The only better system that I can think of is the approach used by the futures market and setup used at the Toronto Stock Exchange. The futures market has multiple MMs involved in a stock like the NASDAQ does. The difference is that the MM is just another trader on the floor along with the other floor traders that have equal access to taking the other side of each transaction. It is an open outcry system like the listed exchanges which has its advantages with respect to fair market pricing. But for illiquid instruments, there are still the MM who are present to take the other side of the transaction.
If I am not mistaken here, the TSE is a hybrid of the futures market where there is an electronic book that is accessible to outside traders. I understand that many of the MMs have gone "upstairs" to transact business electronically like the MM of the NASDAQ. So I think some advantage is lost in this arrangement compared to the open outcry system of the futures markets and the listed exchanges. However, every trader along with the MM has equal access to take the other side of an order unlike the NASDAQ system. This will not allow for collusion between the MMs which happens frequently with the NASDAQ system. Someone please correct me here if I am wrong.
So in summary, I think the specialist of the listed exchange in not in the position of manipulating most prices on the exchange like some seem to think. NASDAQ is a different story where price manipulation is not uncommnon.
Comments?
Bob Graham |
