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ECON394Lecture21OverviewofMarketStructureTheSecuritiesandExchangeCommission(SEC)wascreatedin1934.StockexchangesareregulatedbytheSEC,buttheyareconsideredself-regulatoryorganizations(SROs)withconsiderablelatitude.ThemajornationalstockexchangesaretheNewYorkStockExchange(NYSE)andtheAmericanStockExchange(AMEX).In1998,theNationalAssociationofSecurityDealers(NASD)acquiredtheAMEX.ItthensoldtheAMEXin2003toaprivateequitygroupforonly$110million.TheNASDregulatesanelectronictradingnetworkcalledtheNASDAQ(NASDAutomatedQuoteSystem).TheNASDwentpublicin2001,tradesunderthesymbolNDAQandisnowcalledtheNasdaqStockMarketIncorporated.Afunnynameforanexchangethatisnotastockmarket(atleastaccordingtotheSEC).ECON394Lecture22TheNewYorkStockExchangeStockmarketsliketheNewYorkStockExchangeprovidestrictcriteriaforsharestobetradedontheirexchange.Forthisreason,theyarestillcalledlistedsecurities.NYSEFactsandFigures:U.S.listingrequirementsDailytradingvolumeMarketcapitalization10LargestCompaniesECON394Lecture23TheNYSETradingFloorVirtualtourECON394Lecture24NYSEParticipantsTogainaccesstothefloor,youmustbuyaseat.Thenumberofseatshasremainedat1,366since1953.Theycurrentlysellforabout$1.5million.EachstocklistedontheNYSEisallocatedtoaspecialist,amarketmakerwhotradesonlyinspecificstocksatadesignatedlocation.Allbuyingandsellingofastockoccursatthatlocation,calledatradingpost.Buyersandsellers-representedbythefloorbrokers-meetopenlytofindthebestpriceforasecurity.ECON394Lecture25TheNYSEAuctionProcessSpecialistsorganizetheauctionprocessonthetradingfloor.Theyprovideinformationaboutthecurrentstateofthemarket,thepriceatwhichsharescanbebought(bid)orsold(offerorask)andthequantityofsharesavailableateachprice,calleddepth.Thedifferencebetweenthebidandofferiscalledthespread.In2001,allU.S.equitymarketswenttodecimalswithaminimumspreadof$0.01.ECON394Lecture26TheSpecialist–Agent&PrincipalSpecialistsactasagents,executingordersentrustedtothembythepublic.Ininstanceswhenthereisatemporaryshortageofbuyersorsellers,NYSEspecialistsactasagents,buyingorsellingfortheirownaccounts.Thespecialisthasanaffirmativeobligationtostabilizemarketsduringseveremarketdownturns,likethemarketcrashofOctober19,1987.Thevastmajority(77%)ofNYSEvolumeisaresultofpublicordermeetingpublicorder--individuals,institutionsandmemberfirmsinteractingdirectlywitheachother.Non-specialistshandle14%andspecialists10%.Note:Therecanbeaconflictbetweenthespecialistactingasbothprincipalandagent.ECON394Lecture27NYSESpecialistFirmsThelargestNYSEspecialistfirmisLaBrancheandCo.whichhandlesmorethan500stocks.Spear,LeedsandKellog(acquiredbyGoldmanSachsin2000for$6.5billion)andFleetMeehanaresecondandthirdwith493and428stocks.Together,these3firmstradeabout2/3ofthedailyvolume.Youcanfindacompletelistonthehere.ECON394Lecture28NYSEOrderBookECON394Lecture29TypesOfOrders-NYSEThesearefourkindsororders:(1)marketorders:anordertobuyorsellafixedquantityatthecurrentmarketprice;(2)limitorders:anordertobuyorsellafixedquantityatadesignatedprice;(3)stoporder:anordertobuyorsellonceadesignated“stop”pricehasbeenhit.(4)stop-limitorders:acombinationofalimitandastoporderOntheNYSE,stopordersbecomemarketordersonceatradehasbeenexecutedatthestopprice.ECON394Lecture210NYSEAutomatedExecutionSystemsSuperDOTADotNYSEDirect+Largeinstitutionalinvestorscanalsotradeinwhatisknownastheupstairsmarket.ECON394Lecture211RegulationNMS(1)Tradethroughrule(2)Accessrule(3)Sub-pennyruleTheoverridingprincipalofanationalmarketsystemistoenabletraderstogetthebestpricesindependentoftradingvenue.ECON394Lecture212SpecialistInvestigationsBackground:Sincedecimalsandwiththedeclineintradingvolumefollowingthebubble,specialistprofitshavedeclined.ThestockpriceofpubliclytradedspecialistfirmLaBranche(LAB)confirmsthis.LABandothersbottomedoutinearly2004whenthe5majorspecialistfirmswerefined$240million.Calpers(amongmanyothers)hassuedtheNYSEtorecoverinvestormoney.Criminalcasesarepending.ECON394Lecture213ExampleOfInterpositioningBidDepthAskDepth41.04541.10441.03241.121241.003641.131ThiswasthestateofthelimitorderbookinonJanuary3,2003at11:04AM.ThestockisVZandSpearLeadsandKellogg(SLKS)wasthespecialist.Thebookalsoincludedmarketorderstobuy3,300sharesandmarketorderstosell2,100shares.Thespecialistcouldhavepairedoffthemarketbuyandsellordersandsatisfiedtheremainingorderfromhisaccountoragainstthelimitordersat41.10and41.12.Instead,thespecialistshorted3,300sharesat41.10,400sharesat41.04,200sharesat41.03,bringingthespreadto41.00X41.10.Atthatprice,hecovered2,100sharesfromthemarketsellorders,earningarisklessprofitonthatportionofthetrade.ECON394Lecture214Grasso’sCompensationDuringhistenureaschairmanandCEOoftheNYSE,RichardGrasso,whohadstartedoutasaclerkofthefloor,receivednearly$160millionincompensation.TheWebbreporthasallthedetails.EliotSpitzerhassuedGrassotorecoversomeofhispaypackage.Thebottomline:thespecialiststocksaredown,tradingvolumeisdown,electronicexchangesareerodingNYSEmarketshare,NYSEseatpricesaredownto$1millionfroma1999peakof$2.5million.MutualfundslikeFidelityareactivelyexploringalternativestotheNYSE.Grassowase