Nothing bores Wall Street like a dull market, which is not to say that everybody was entertained this fall when the Dow Jones Industrial Average stepped off a cliff. In two days, Sept. 11 and 12, 120 points were stripped from the index in some of the heaviest trading ever known. At the New York Stock Exchange no one had seen such a sell-off in 20 years.
On the floor of the exchange, not far from its entrance at 11 Wall St., Jimmy Jacobson and his brother Robert Jr. were supervising trading in several stocks that were getting hammered. Anheuser-Busch, Kellogg and United Technologies were sharply down. Nearly from the opening bell, the brothers were inundated by paper, almost all of it marked "sell."
"It was like you were standing under Niagara Falls," remembers Jimmy, a serene-looking man with neatly combed dark hair, "not knowing if anyone was ever going to turn off the water." At the end of the two days, more than $150 million worth of stock had passed through the books of Benjamin Jacobson & Sons, all of it headed south, and the firm had taken a loss of a quarter of a million dollars.
Across the floor, Robert B. Fagenson was also thinking in imagery derived from the Deluge. "It was as if you were standing in the surf with the tide coming in," he says. "You sweated, you cried, there was nothing you could do." At regular intervals, Fagenson would see a phalanx of floor brokers come around the corner of the trading post to his right like zombies on the march, bearing orders to sell their stock at any price.
Any sensible man would flee for the exits at a time like this. But the stock exchange's specialists--men like the Jacobson brothers, Bob Fagenson and 419 other brokers on the NYSE floor--are required by exchange rules to hold on for dear life, trading stock from their own accounts against the prevailing flow.
Part auctioneer, part dealer, part mediator, the specialist is the figure who most distinguishes the New York Stock Exchange from much of its competition among the world's major stock markets. Using their own money and bank loans to trade, these independent brokers are charged with keeping an orderly market in each stock assigned to them by the exchange. That's a chore so demanding in today's disorderly and volatile stock market that some critics have taken the opportunity to resurrect old questions about whether the specialist system will survive.
These are not the pin-striped, yellow-tied chaps the public generally associates with Wall Street. These are the hard laborers of the market. As the din of traders' shouts ricochets off the exchange's high marble walls, the specialists' jaws incessantly work on wads of chewing gum to ease the tension of making a thousand split-second decisions in a 6 1/2-hour trading day. They grow splayfooted from years of standing on the hardwood floor or leaning back with their elbows on the waist-high counters of their trading posts.
They have no use for the research reports that the big brokerages sell to investors by the trainload, all purporting to give a rationale for buying or selling a stock.
"When your investment horizon is to buy for breakfast and sell before lunch, you can't be too wedded to opinion," Fagenson says.
In return for committing his own capital to supervise the trading in his stocks, the specialist is awarded a coveted franchise, producing profits that are the envy of every other business on Wall Street, as well as salaries that can range into six figures.
As long as a stock is trading within a narrow range, as most do when they're not being driven straight up or down by a news report or a market panic, the specialist's position directly at the center of trading gives him a distinctive opportunity to make money buying and selling shares at prices just cents apart.
Without a specialist, a line tracing the price of any widely owned stock would resemble the Sierra--peaks separated by sharp notches. Take a stock selling for $20 a share. If a 100,000-share buy pumps the stock up $2, in the next moment a 200,000-share sale might kick it down by $2.50. Good luck to any investor trying to trade that stock at a fair price while it is careening from $10 to $12 and back down to $9.50 over a matter of minutes.
"It's the function of the specialist to iron out these short-term differences," says William C. Freund, a business professor at Pace University who spent 18 years as the Big Board's chief economist. The ideal is for the specialists to keep the market so orderly that each trade takes place at a price within an eighth or a quarter of a point of the previous trade.
In simple terms, the specialist does this by trading a stock in opposition to its short-term trend. When everybody else is buying, he is selling, and vice versa.
The specialist also maintains a book of "limit orders," which are purchases or sales to be executed for customers when a stock's price reaches a specified level. For such trades, he receives a commission.
It is not a job that has become any easier in the 100 years or so since an exchange broker first had the brainstorm of specializing in a specific security. Over the years, specialists have regularly found themselves the object of one challenge or another to the exchange's way of doing business, or to its very existence.
Twenty years ago it was block trading--in which institutional investors buy and sell stocks in slabs of hundreds of thousands of shares at a swipe--that challenged the capacity of the relatively under-financed specialists to supervise their markets. But the specialists and the institutions found ways of moving these blocks as partners, facilitating the trades and preserving the specialists' franchise.
Then the advent of computers inspired headlines asking, not quite rhetorically, if the specialist was finally dead. But the exchange managed to modernize the floor with a computer system so powerful that, almost without breaking a sweat, the specialists can now handle the clerical aspects of trade volume peaking at nearly 250 million shares a day.
Yet Wall Street is changing so fast, and in such unexpected ways, that the questions keep coming. There is the New York Stock Exchange's steady decline in market share. Just as the TV networks face the encroachment of cable and the VCR, the Big Board has lost its iron grip on trading in the roughly 1,500 stocks it lists. An investor can trade a Big Board stock in a dozen other places, whether a regional market like the Pacific, Boston or Philadelphia stock exchanges, or one of the so-called third-market brokerages that arrange trades without recourse to the NYSE floor.
Then there's the over-the-counter market, once regarded as a haven for stocks not mature enough for Big Board listing but now boasting the technological ability to handle trading in any stock of Big Board magnitude. Shunning the centralized trading that takes place within the specialists' earshot, the OTC market operates entirely over the telephone. An investor can get a price from any of a potentially unlimited number of brokers, known as "market-makers," who may keep an inventory of a given stock and whose price may or may not be the best available. A professional institutional trader has the time and access to seek out the best price, but the smaller investor may be flying blind.
"Where the specialist shines is in serving the individual investor," Freund says.
Increasingly, however, institutional needs govern the market. Institutions that are equipped with global telecommunications networks and are unwilling to bring their orders to a central location have wiped out the NYSE-style auction system almost everywhere. The latest to go was the London Stock Exchange, which last month changed from an auction system to an OTC-style market.
The change, known as the Big Bang, left only the NYSE and the much smaller American Stock Exchange as major markets where agents of the buyer and the seller of every block of stock meet face to face in a central location to negotiate.
Not least of the challenges facing the exchange specialists is the flow of the market itself. Days like Sept. 11 and 12 come much more frequently now, driven by a process known as "program trading," in which institutional traders following the dictates of computer programs can dump on the floor orders for tens of millions of shares of a hundred stocks within seconds. All those 30- and 40-point spurts and headers that put the Dow Jones average on Page 1 are caused in some respect by program trades. If the specialists accept their responsibility to level out their stocks' short-term swings, none of them feel prepared to stand entirely in the way of dam bursts like these.
"At these times you just try not to get killed," says Robert J. Jacobson Sr., known around the floor as "Senior." "Once the trading quiets down, you always have a chance to recover."
The specialists are also the floor's institutional memory. Earlier this century, the floor's habitues included the senior partners of all the great investment houses--Witter, du Pont, Goodbody, Hutton--some of them remembered only in corporate letterheads, some long ago consigned to oblivion. It was as if the very capital of Wall Street was standing within the marble walls in spats and silk hat, deciding on the spot where to deploy itself.
Today the senior partners of an investment firm are insulated from the floor by layers of financial bureaucracy. A firm's floor broker is an employee taking his orders from another employee at a trading desk in the great world that the people on the floor refer to simply as "upstairs." The upstairs trader might be getting orders from someone else, all in pursuit of a complex computer-generated strategy.
However, it is still common to hear a partner in a specialist firm begin his conversation about how the exchange has changed in the last 50 years with: "When my father first came here. . . ." To many, the crash of '29 is a page out of family history; personal milestones might be marked by the price of the stock-exchange seat when Dad bought it in 1951, and the value it fell to in the bear market of 1962. In some cases, individual stocks have belonged to the family book for decades.
So when the NYSE's cherished auction system--established when a group of traders signed a compact under a buttonwood tree on Wall Street in 1792--is threatened, not only the specialist's way of life but also his patrimony is jeopardized.
Bob Fagenson is a sandy-haired man of 37 whose stocks include Walt Disney Productions. (When Disney celebrated the 25th anniversary of its NYSE listing, he arranged to have Mickey Mouse flown up from Disney World to wave to the brokers from the exchange gallery.) He remembers hearing how his father started in 1932 as an independent floor broker.
Then, as now, these people were known as "$2 brokers," after the commission rate they charged then on each block of 100 shares. "He had to start a business fixing cash registers on the side," Fagenson recalls, "because he was only making $4 a day." In time, Fagenson & Co. became one of the floor's largest firms, specializing in more than 60 stocks.
The history of the Jacobson firm goes even further back. It begins with Jimmy and Bobby's grandfather, Benjamin Jacobson, known as Popsey, who founded the family business more than 55 years ago. By then he had been working on the floor 26 years, first as a page and later as a floor trader for a conservative old-line firm. The firm's partners bought Popsey an exchange seat in 1923; six months later the senior partner died. His successors, too conservative to risk their own capital trading stock on the floor when their separate commission business was a risk-free moneymaker, offered to let Popsey keep the profits and losses from trading in return for all the commissions he generated for them.
Popsey traded so well that by 1926 he was the firm's senior partner. Then came the crash of 1929. In 1931, with Wall Street still under its historic cloud, Benjamin Jacobson formed his own partnership.
The Jacobson brothers' boyhood heroes were people like Robert Stott Sr., whose name, unknown outside the marble walls, still inspires awe within them. "We dreamed of being able to trade like Bob Stott," Jimmy says.
Popsey's son and grandsons do their reminiscing during a lull in the market, during which the floor's passion for trading works itself out on whatever commodity is available. At the moment, the commodity is food, and there is a vigorous market in pizza slices and soft drinks. The lull continues through lunch, until the crowd of floor brokers is overcome by a frenzy of whooping, jostling, mussing of hair and grabbing at clothes that resembles nothing so much as puppies playing.
The locker-room atmosphere and practical joking are legendary. They are inevitable in any institution in which men are in close quarters all day and given to understand that they have more in common with each other than with anyone outside. The exchange floor is one place where people meet as colleagues, whether bred in the poolroom or on the polo grounds. (Still, the floor has not shed all of its clubbiness. Of its 422 specialists, 600 commission brokers working for investment houses and 200 $2 brokers, perhaps 50 are female, and fewer are black.) In earlier times the roughhousing had all the sophistication of Mack Sennett. One floor trader was famous for his aim with a water pistol; another gang had such artful technique with shaving cream that they could pile it a foot high on someone's shoes before he noticed.
Not long ago, one of the Jacobson firm's specialists had the misfortune of handling the books on three stocks that were battered mercilessly for an entire week. The following week, the Jacobsons ordered a new badge for the broker, in black with stark white letters: "Doctor Death."
"They had a dozen black roses delivered to me," says the broker, shaking his head. "With everyone watching, right here on the floor."
But all this is abandoned when the trading turns active. At such times a specialist scarcely has time to do anything but manage the crowd of floor brokers in front of him and pop a stick of chewing gum. Keeping the flow of orders airborne, he must also juggle the rules governing his own trading. He is forbidden to execute a trade for himself ahead of anyone in the crowd with a similar bid or offer, and he is required to step aside as long as buy and sell orders can be matched within the crowd or from his book of previous bids. Yet he is also expected to make a bid or offer, going into debt if necessary, to bring the bid and offer prices in the crowd close enough to facilitate deals.
Supervising the frenetic throng that accumulates around the post of an active stock can take its toll on the specialist. Such was the case with CBS Inc., the target of unrelenting takeover activity for nearly 18 months starting in April, 1985. At the end of a trading day John M. DePiro, the CBS specialist, could be found slumped in the exchange's dressing room, debilitated by the pressure of making instant decisions in the midst of a howling mob of floor brokers, hour after hour, for days and weeks on end, with millions of dollars of his firm's capital at stake every moment.
"I was spent," says DePiro, 52, a short man with reading glasses perched on his nose and stringy black hair brushed straight back. "It went on month after month after month. It cooled off for a month and a half, then it went crazy again."
Many of the specialist "books," the order ledgers for individual stocks, are now computerized, but CBS is not. Each day, the CBS post would be enveloped feet-deep in paper; inevitably, a serious mistake was made and an order lost, a situation that generally requires the specialist to cover the order anyway.
DePiro says: "You know how when you lose an order ticket it's never for 100 shares? This one was for 14,000." Making the order good cost his firm more than $70,000.
Yet the floor has specialists for whom a string of days like DePiro's would have the bracing effect of a set of tennis. There's DePiro's partner, Robert A. Scavone, considered one of the most skilled traders.
Scavone was a Brooklyn kid who started as a page at 17 and rose over more than three decades to become the top executive of one of the leading specialist firms. When it was bought out not long ago, he retired--for a month. He returned as a partner in McKenna, Cloud & Co.
On the trading floor, Scavone is constantly in motion, pacing in front of his post, his shoulders twitching, his eyes darting back and forth. At lunch in the seventh-floor Stock Exchange Luncheon Club he sits in the bar section in back so he can keep his eyes fixed on the green lighted ticker overhead.
Having come onto the floor without the cushion of a family firm or political connection, Scavone is a great believer in the rigorous regime of the numbers. A specialist's skills are on display all day, but especially at the end of the day, when his own trading profit or loss is calculated.
"This is a high-intensity job," he says. "You have to love it. The best trader is the one with natural instinct. Natural instinct. This is one business where you can say, 'Don't tell me how good you are--I have the figures. I can see.' Being a specialist is like having a batting average.
"Sometimes you wake up and you're dreaming you're trading. Sometimes you wake up at 2 or 3 in the morning and you just pace. I had a pace room in the house. With a TV set and a couch, cathedral ceilings. My wife had it furnished." He laughs. "I'd actually work up a sweat. Go to sleep at 6, wake up at 7."
Occasionally, program trading provokes a wave of buying or selling that strikes hundreds of stocks nearly simultaneously, generating enough activity to challenge the stamina of a dozen Bob Scavones.
Everything about program trading is automated. Inside a wooden cabinet on the wall of the floor booth for Salomon Bros. or some other major institutional trading house will be thousands of order tickets preprinted with the name of a stock and the word buy or sell . Arranged according to an elaborate code, they are stacked like so many mummies awaiting a secret incantation to spring from their catacomb and stalk the floor. These are the program orders. The phone rings, a code is uttered. The clerk calls in the firm's own floor brokers and as many $2 brokers as can be raised on their pagers, and sends them out with the inscribed tickets.
Normally a floor broker is expected to exercise his initiative once he gets his instructions from the upstairs trading desk--turning down a bid at one-eighth if he senses it might come back a minute later at one-half, for example. When the programs hit the floor, however, all such discretion evaporates. Price becomes irrelevant.
"You see the brokers come around the corner with the program tickets in their hands," Fagenson says. "They'll have absolutely no concern what the price is. I'll stand right here with my hand out. Boom! A broker slaps in an order to sell 6,500 shares. I say, 'But the price. . .' He'll say, 'Sell it!' Boom! Another order for 7,000 shares. I'll say, 'But. . .' 'Sell it!' "
Days like this inspire the specialists to reminisce about great losses they have known. In an enterprise in which it is a matter of pride that a man bought high and sold low to maintain an orderly market in his stocks, taking a heavy loss is something of a badge of accomplishment.
That is when the value of the specialists' old-boy system also emerges. In 1977, when Fagenson & Co. took the largest single one-day loss in specialist history, a $2.5-million bombshell in a stock called Frigitronics that was being manipulated by an upstairs broker, the firm was rescued from near ruin by the Jacobson brothers.
"Our fathers went back a long way," Fagenson says. "I can still remember Bobby Jacobson telling me, 'Trade with our capital as if it were your own money.' "
Bobby Jacobson says the episode was a way of repaying the specialists' fraternity for the assistance it had given his own family years ago, when it found its trading in an active stock being undermined by a clerical logjam at the upstairs firm handling its clearing, the crucial process of reconciling orders coming off the floor.
On that occasion, the Jacobsons recall, it was their idol, Bob Stott himself, who stepped in to help, offering the services of his firm's clearing department and refusing to take a cent for security.
Such continuity notwithstanding, the business of the floor has changed radically with the years. "If we could only trade with today's volume under yesterday's rules," Fagenson says, laughing, "we'd be making unimaginable money."
Yesterday's rules, however, were the product of an entrenched monopoly, when anyone wanting to trade an exchange-listed stock had only one place to do it: 11 Wall St.
During the monopoly years, "you used to be an adversary of the customer," says Robert Jacobson Sr. If a broker approached a post with an order to sell 20,000 shares of Pierce-Arrow, the specialist would consider himself under no obligation to confide that there was another order outstanding to buy 50,000. Instead, the specialist himself might buy the first block at a price a quarter lower than the last sale. Then he would turn around and resell the shares to the bigger bidder, taking for himself a profit that properly belonged to his customers, the brokers. A broker had no recourse but to nurse his grudge and dream of one day repaying the specialist in kind.
Now an irked institutional trader can shun the NYSE. The necessity of changing their mind-set from being the only game in town to being the best among several is not lost on those on the exchange.
Where discipline on the floor was once exacted firmly, but unofficially, by people like John A. Coleman Sr., a specialist of daunting sternness, in 1975 the exchange formalized its procedures, distributing questionnaires to floor brokers to rate each specialist unit and promising to take stocks away from low performers. Although no one can remember a specialist losing his book for disciplinary reasons, a poorly rated unit faces the threat of not winning the assignment of newly listed stocks. In a period when the NYSE loses about 100 listings a year to mergers and acquisitions and scarcely makes up the difference with new listings, a firm that fails to get new assignments will wither away.
"We lose two to four stocks a year to takeovers and other things," Bob Fagenson says, enviously looking over a flyer announcing that specialist applications are being accepted for Coca-Cola Enterprises, a Coke spinoff that will be one of the largest new issues in history.
"This is going to be a fabulous stock," he says, imagining the profits to be made on an issue with a float of 71.4 million shares. "Unfortunately, we don't stand a chance of getting it."
In the last quarter, he confides, Fagenson & Co.'s ratings have skidded, driving down the firm's rank by 25 places.
In some ways the rating system has made the specialists and their customers adversaries again. Think of the quandary of a specialist appointed a floor official, empowered to decide trading disagreements. "There's always one winner and one loser," Jimmy Jacobson remarks one day after deciding two disputes.
He turns to the matter at hand: opening the trading on a company known as Chemical Waste Management, a spinoff of the larger Waste Management Inc. and known in exchange argot as "Son of Waste." In the minutes before the 9:30 a.m. opening bell, Jacobson is fielding the floor brokers' shouted queries on the likely opening price and the size of the buy and sell orders on the tickets accumulating in his palm. He matches up the orders he can, and calculates how much of "Son of Waste" he will have to sell out of his firm's account to meet the remaining buy orders at a reasonable price.
A minute passes, and so begins 6 1/2 hours of buttonholing and haggling over terms, then executing the deals through a computer system second only in power to NASA's. Small wonder that critics think the disparity between the face-to-face dealing on the floor and the Space Age systems that support it should be resolved--in favor of technology.
"When that group met under the buttonwood tree to trade securities 194 years ago, that was the state of the art then," remarks Gordon Macklin, who as chairman of the National Assn. of Securities Dealers, the sponsor of the OTC market, is regarded by almost every specialist as the archenemy. "Today, it wouldn't occur to you to bring everyone together in one location to trade. We're not saying their system is poor, but as you look ahead, the market of tomorrow will not be centered in one marble hall."
Fagenson considers the issue. At his right shoulder his tall, solidly built partner, Steven Axelrod, is supervising a busy crowd's trading in Salomon Bros. stock, with a voice like a cannon and the authority of a drill instructor. ("It's a mean stock, and I'm a mean guy," Axelrod cracks.)
"Macklin puts on his rumpled suit and goes on his crusade," Fagenson says. "But you can't tell me that system benefits anyone but the brokers. On this floor we're committed to one thing: getting the best price and the fairest execution for every investor in the market."