CalPERS Sues NYSE, Specialist Firms

Times Staff Writer

The California Public Employees’ Retirement System sued the New York Stock Exchange and its seven “specialist” firms Tuesday, alleging that improprieties in the NYSE’s tradition-bound trading system have cost U.S. investors more than $150 million over the last three years.

The lawsuit, which seeks class-action status, was spurred by a Securities and Exchange Commission investigation into the specialist firms, which operate on the NYSE trading floor as middlemen between buyers and sellers of stock.

CalPERS alleges that the specialists used their unique position to trade for their own accounts, putting their interests ahead of the investors they are supposed to serve. The NYSE turned a blind eye to the trading violations, the pension fund charges, because the exchange and its top officers “directly benefited from the wrongdoing.”

The lawsuit marks the latest attempt by California pension officials to exert influence on the workings of the world’s biggest stock exchange. CalPERS was a leading member of the group of state treasurers and pension officials that helped force the ouster this fall of former NYSE Chairman Richard Grasso after revelations about his outsized pay package.


The SEC is scheduled to vote today on a package of reforms proposed by interim NYSE Chairman John S. Reed. California officials indicated that they didn’t think Reed’s changes went far enough. They said their lawsuit, which seeks an unspecified amount of restitution for investors and the repayment of ill-gotten profits, was designed to press regulators to demand greater change at the NYSE.

“Our patience has run out,” California State Controller Steve Westly said. “The NYSE must take responsibility for its failure to govern itself. We will hold the NYSE accountable not only for restoring fairness but for restoring investor dollars.”

Among other things, California officials want the NYSE to jettison the specialist system in favor of an electronic trading arrangement, similar to the one used by the Nasdaq Stock Market. Traders for the specialist firms that operate at the NYSE oversee all trading, personally stepping in to buy or sell securities when necessary to assure an orderly market. On Nasdaq, buyers and sellers are automatically matched by computers.

Because specialists help run the NYSE, which is charged with regulating the specialists, conflicts of interest are rife, state officials said.

CalPERS, the nation’s biggest pension fund with $152 billion in assets, is seeking other investors who traded on the NYSE over the last five years to join the suit as a class action.

The SEC and the NYSE declined to comment on the suit.

The seven specialist firms are LaBranche & Co.; Bear Wagner Specialists; Spear, Leeds & Kellogg Specialists, a division of Goldman Sachs Group Inc.; Van der Moolen Specialists USA; FleetBoston Financial Corp.'s Fleet Specialist Inc.; Performance Specialist Group; and Susquehanna Specialists.

Most of the firms declined to comment, saying they hadn’t reviewed the charges in the suit, which was filed in U.S. District Court in Manhattan. Shares of the firms with publicly traded stock fell on news of the lawsuit, with LaBranche sliding 7.1% on the NYSE and Van der Moolen’s NYSE-traded shares losing 6.7%.


Todd Silverberg, general counsel of Susquehanna’s parent company, said the firm usually didn’t comment on ongoing litigation, but said there was “no factual basis” for Susquehanna to be included in the suit.

Securities experts were divided on the effect the suit ultimately might have. But some noted that CalPERS had targeted practices often complained about by NYSE customers.

“A lot of institutional investors that I talk to say they consider the specialists to be their biggest competitors, rather than facilitators,” said Junius Peake, professor of finance at the University of Northern Colorado.

In October, the NYSE said its own investigation had turned up trading abuses by five specialist firms from 2000 through 2002. But NYSE officials said the questionable trades involved about 2 billion shares in all -- equivalent to about one day’s volume.


On Tuesday, a spokesman for the specialists said improper trading was rare and the benefits of human specialists far outweighed the risks.

“In an electronic market, there is no one accountable for the trading in a stock,” said David Humphreville, president of the Specialist Assn. in New York. “The specialists are accountable for their behavior. They add liquidity; they facilitate putting buyers and sellers together. By almost every measure, we are the most efficient fair market on Earth.”

Specialists are supposed to step aside when there are investors willing and able to execute a trade with each other. CalPERS alleges that in some cases, specialists improperly stepped in and bought shares from one investor, then sold them to another seconds later at a slightly higher price.