The American Stock Exchange: Scandal on Wall Street

In the April issue of the New York Stock Exchange monthly newsletter, Chairman Richard A. Grasso made a rare and embarrassing admission. The Securities & Exchange Commission had commenced an investigation at the NYSE. And the target was not a rogue broker, insider trader, or some other transgressor, but rather the NYSE itself. Under scrutiny is a subject that could not have been more fundamental to the operations of the nation's premier stock exchange: Has the NYSE adequately regulated the brokers who execute trades on the exchange floor?

With word of the SEC probe, the scandal scorecard for U.S. stock markets became a decisive, and apparently definitive, score of 2-1: two stock markets tarred by scandals at the millennium's close, and one untouched for the greater part of two decades. The NYSE, which pledged cooperation with the SEC, has had to cope with the aftermath of a federal court indictment last year alleging improper trading by floor brokers. Its archrival, NASDAQ, has been bruised by incessant micro-cap scandals and by accusations, in lawsuits and in an SEC report, that NASDAQ market makers were conspiring to fix prices. The exception, the apparent island of relative tranquility, was that venerable Wall Street institution, the American Stock Exchange.

NO PROBES. To be sure, the Amex has had its troubles--notably a longtime weakness in luring and holding top-notch equity listings. Five years ago, it wrestled with concerns about the quality of some of the smaller companies listing on the exchange. And the Amex is in transition. In a few weeks, the exchange will be losing its chief executive officer, respected economist Richard F. Syron, and it has entered a potentially rocky partnership with NASDAQ. But the Amex brings to the merger a fast-growing options business and something the NASDAQ is striving to attain--a reputation for integrity that is second to none. Amex officials note with pride that its floor membership has not been subject to a single criminal indictment or major SEC investigation since the late 1970s. As Syron takes his leave, the Amex's public image has never been better. ''Before he leaves June 1,'' Barron's observes in its Apr. 12 issue, ''Dick Syron could be forgiven if he took a victory lap around the old Curb floor.''

But on the ''old Curb floor,'' not everyone feels much like cheering. For there is another Amex that has remained in the background--and is considerably darker than the one in the public eye. This Amex was the subject of a six-month investigation by BUSINESS WEEK. And what emerged was, in its own way, more troublesome than the difficulties encountered by its two competitors. Unlike the scandals that rocked NASDAQ and the NYSE in recent years, the troubles that have beset the Amex have had absolutely no publicity. But they have not been secret by a long shot. For the difficulties besetting the Amex have taken place under the noses of the Amex officials charged with enforcing the rules of conduct on the Amex floor.

BUSINESS WEEK interviewed traders, floor brokers, specialists, and clerks, as well as current and former Amex officials and current and former federal and local regulators. We also reviewed thousands of pages of documents, most not publicly available. What emerged was a multifaceted, often complex story with but one common theme: The American Stock Exchange has failed to adequately police itself. It is a failing that seems most vividly apparent when its most powerful and influential firms and personalities are involved.

The key findings:
-- Amex options specialists and traders are said to regularly engage in price-fixing. The aim is to keep as wide as possible the ''spread'' between the bid--what the public can get to sell an option--and the ask, which is what the public must pay to buy an option. Because the prices are allegedly skewed to favor the denizens of the Amex floor, the public is hurt each year, BUSINESS WEEK estimates, to the tune of $150 million. The Amex denies knowledge of improper options pricing (page 99).

-- Amex sources maintain that a host of other trading improprieties are commonplace. Chief among these are what they describe as illegal trading by floor brokers and specialists, similar to the accusations in the indictments of the NYSE floor brokers. But Amex officials say that there is no broad SEC inquiry--of the kind just announced at the NYSE--into how the Amex regulates its floor personnel.

-- With the SEC's tacit concurrence, the Amex routinely doles out light punishment when it uncovers wrongdoing on the floor. In contrast to its merger partners at NASDAQ, who work closely with the SEC and federal and state prosecutors, the Amex deals with most allegations of even serious wrongdoing ''in the family'' (page 108).

-- The American Stock Exchange's scandal-free reputation is a mirage. Since 1995, the Amex floor has been rocked by a major floor-trading scandal involving alleged improper trading by Pasquale Schettino, a top official of its most powerful specialist firm, Spear, Leads & Kellogg. The Amex apparently did not follow up on testimony indicating knowledge and approval of Schettino's activities by top Spear officials--including its former senior partner, Peter R. Kellogg. Spear and Kellogg, who were not charged by the Amex, declined to comment, as did Schettino's lawyer (page 102).

-- Allegations have been made regarding another influential force on the Amex floor, specialist Joseph Giamanco, who heads the specialist firm GHM Inc. Persons familiar with Giamanco's operations maintain that he has, for years, traded for his personal profit in stocks of companies in which his firm specializes. If so, that would be a serious violation of exchange rules and would fall afoul of the federal securities laws if nonpublic information was exploited. Giamanco's attorney denies that the veteran specialist has committed wrongdoing (page 104).

-- Specialists are permitted by the Amex to obtain cut-rate ''cheap'' stock in publicly traded, chiefly micro-cap companies. This practice--which is legal and sanctioned by the exchange--raises the danger that companies may give influential Amex specialists cheap stock to get their support for listing company stock on the Amex.

-- The Amex, the SEC, and law enforcement have failed to adequately investigate numerous allegations of improprieties at the Amex that were made in recent years by an options trader turned whistle-blower, Edward R. Manfredonia (page 110). The Amex maintains that Manfredonia's allegations were investigated and dismissed as without merit, and the SEC says his letters were forwarded to the appropriate officials. But officials privately concede that little weight was given to his allegations--important aspects of which were substantiated by BUSINESS WEEK's investigation.

PROBLEMS FIXED. To be sure, none of the Amex's hidden troubles necessarily overshadow the many positive developments at the Amex in recent years, particularly since the appointment of Syron, its chairman since 1994, who previously was CEO of the Federal Reserve Bank of Boston. There's no denying that the Amex has made headway against its nagging problems--lagging listings and weak equity trading volume. In recent weeks, the Amex lost its largest stock listing--Viacom, which accounted for some 4% of all volume on the floor of the exchange. But for every such problem in recent years, there has been a solution in the form of a new product--such as its series of well-received index-linked equities based on the Standard & Poor's 500-stock index. The S&P index products are issued under an agreement with The McGraw-Hill Companies, which publishes BUSINESS WEEK and owns S&P.

In an interview with BUSINESS WEEK, Syron vigorously defended the Amex's record as a regulator. He expressed surprise and concern about the allegations concerning the options market--but also dismissed them as routine grousing. ''I think over the last several years...there's always room for improvement, but [we have done] a pretty good job here in the regulatory climate at the Amex,'' asserts Syron. Another high Amex official, speaking privately to BUSINESS WEEK, also expressed surprise at the allegations and the hope that floor personnel would bring any allegations of improprieties to his attention.

But on the floor of the exchange, such sentiments would be viewed with disdain. Indeed, the brokerage officials and Amex floor personnel, current and former, of all levels of seniority, who were interviewed by BUSINESS WEEK did so on condition of confidentiality--in the belief that their livelihoods would be ruined if they were known to be talking to the press.

For the National Association of Securities Dealers, which now runs both NASDAQ and the Amex, the implications of the Amex's hidden troubles are serious. The Amex will continue to regulate itself despite the merger, albeit under the NASD's general aegis, because the merger leaves intact the Amex's enforcement and surveillance apparatus. But what becomes of a corporate culture that, people on the floor maintain, turns a blind eye to improper conduct?


To read a letter to the editor about this story, click here.

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COVER IMAGE: Scandal on Wall Street

Price-Fixing, the Amex Way

TABLE: Why Are These Options Spreads So Wide?

TABLE: How the Two-Tier System Hurts the Public

A Double Life at Spear Leeds?

Did a Specialist Break the Rules?

The Flaws in Self-Policing

The Gadfly of Trinity Place

ONLINE ORIGINAL: Why More Investors See Options as a Necessity

E-Mail to Business Week Online

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