April 19, 1999
SEC Is Looking Into Certain Practices
Of Options Exchanges, Floor Traders
By GREG IP and MICHAEL SCHROEDER
Staff Reporters of THE WALL STREET JOURNAL
The Securities and Exchange Commission is conducting a wide-ranging
inquiry of how the nation's options exchanges and their floor traders list
and price options.
The inquiry, which has been under way for
several months, appears to focus on whether
collusion may exist among exchanges on the
listing of options, or among traders on their
pricing, according to a request for documents sent to the exchanges in
late
March.
The SEC inquiry is separate from an investigation already under way by
the Department of Justice into whether the exchanges have restrained
competition by agreeing not to list certain options on more than one
exchange. About 60% of options are listed on only one exchange owing to
a longstanding informal agreement.
The SEC also is looking at the regulatory practices of the exchanges.
People close to the matter say the SEC is particularly concerned about
the
self-regulatory record of the American Stock Exchange. The Amex now is
owned by the National Association of Securities Dealers, parent of the
Nasdaq Stock Market.
Spokespeople for the Philadelphia Stock Exchange, Pacific Exchange, and
Chicago Board Options Exchange confirmed receipt of the SEC's request
for documents. An NASD spokesman declined to comment.
The SEC has asked for documents going back to 1989 on any discussion
related to multiple listing of any option; on rules or policies related
to the
"setting or fixing" of prices, quotes or bid-ask spreads including those
on
automated-quotation systems; on how orders are allocated among floor
traders; and on "possible coordination, collaboration, collusion, agreement,
arrangement or understanding" among traders about the fixing of prices,
quotes or spreads.
It also has asked for any documents on "retaliatory conduct against"
traders who may have refused to participate in any collusion, and on
complaints or actions regarding "improper application" of the exchanges'
self-regulatory powers.
People close to the inquiry said the SEC is less concerned about overt
price collusion, as was found on the Nasdaq in 1996, than the possibility
that the options market's structure systematically hurts individual investors.
The inquiry thus meshes with separate initiatives now being pressed by
SEC Chairman Arthur Levitt to link the options markets to ensure that a
customer gets the best price in the country no matter where it is displayed.
Last week, Mr. Levitt wrote to major brokerage firms asking that they
"redouble their efforts" to ensure customers get the best possible price
for
options orders.
People close to the inquiry say the SEC is concerned the Amex is
systematically not bringing enforcement cases, which is reminiscent of
the
Nasdaq probe. SEC examiners have been at the New York-based Amex
for several months, these people say.
One case that has attracted attention on the floor relates to Pasquale
"Pat"
Schettino, a former head of Amex professional-clearing operations for
Spear Leeds & Kellogg, the largest specialist firm on both the American
and New York stock exchanges. In November 1996, Mr. Schettino was
charged by the exchange with trading in 1994 and 1995 without his
employer's approval, wrongfully trading in stocks and options in which
Spear Leeds was the specialist; and creating fraudulent transactions that
weren't publicly reported. Although people knowledgeable about the case
say a panel found against Mr. Schettino last year, Mr. Schettino, who
disputed the charges, has appealed and thus the exchange hasn't disclosed
the case. Spear Leeds wasn't charged in the matter.
A Spear Leeds spokesman said Mr. Schettino is no longer with the firm,
and declined to comment further. Mr. Schettino's lawyer, Eric Levine, also
declined to comment.
The Schettino matter, and allegations of price-fixing at the Amex, were
reported in the latest issue of Business Week.
In a statement Friday, NASD Chairman and Chief Executive Officer
Frank Zarb said, "The NASD and Amex take seriously our regulatory
obligations and follow-up all claims of improper activity in any of our
marketplaces."
Industry participants say some Amex practices may hurt investors, but that
many of the same practices occur at the other exchanges. For example,
Amex specialists may occasionally post wider bid-ask spreads on their
electronic screens than those at which market makers in the "crowd" are
willing to trade, giving the appearance of a "two-tier" market. "It certainly
isn't customer friendly," says an options trader at one Wall Street
brokerage firm. But industry experts say that on all exchanges customers
often can find better prices in the crowd than on the screen. "It's 100%
within the rules," said one options manager at a Wall Street firm. "Is
that
collusion at all? No."
Andrew Friedman, an attorney bringing a class-action lawsuit against the
options exchanges, says some former options traders have told him
two-tier markets do exist on options exchanges. But he says nothing he
has found shows any problem particular to Amex.
Indeed, the SEC appears concerned that by their nature rather than intent,
electronic automatic-execution systems can disadvantage small investors.
For example, a small sell order sent electronically might execute against
a
specialist's displayed bid of 4 3/8, while a floor broker with the same
order
might have found a market maker in the crowd willing to pay 4 1/2. Firms
tend to use floor brokers for larger, more difficult orders.
But industry participants point out that while customers give up the
possibility of price improvement with automatic execution, they gain speed
and certainty.
Separately, the complications arising from the government investigations
are making it harder to close the Amex's planned merger with the
Philadelphia exchange. An executive in Philadelphia said, "There are
serious issues that may make it impossible for us to culminate it."
--Aaron Lucchetti contributed to this article.