Is There a Bull Market in "FRONT RUNNING"? Aug 2005 04:00 ET WSJ(8/4) NYSE Probes Firms For Possible Improper Trading (From THE WALL STREET JOURNAL) By Aaron Lucchetti The New York Stock Exchange's regulatory unit is considering enforcement actions against brokerage firms that may have harmed investors by trading on knowledge of their plans to buy and sell stock. "We're in the process of evaluating" some trades that raise questions about whether Wall Street firms used their knowledge of certain types of orders to make money at the expense of their customers, said Robert Marchman, executive vice president of market surveillance at the NYSE. He declined to name the firms, but said that some trades were "under review" for referral to the exchange's enforcement division. The exchange has looked at trading practices at more than 10 large Wall Street firms. Regulators' scrutiny comes as some Wall Street firms generate more profits from proprietary trading. The NYSE also took the unusual step of reminding brokerage firms in a letter Monday of their obligations to disclose their practices and protect customer interests when trading stocks that customers also want to buy or sell. The letter lays out the firms' duties when handling increasingly popular Volume Weighted Average Price, or VWAP trades, in which mutual funds and other investors place orders to buy or sell shares over a specified period for a price pegged to the average, as well as situations in which a brokerage firm submits a so-called blind bid in response to a customer's request, without knowing all the details of the trade. The NYSE letter is intended to express the exchange's concerns before the issue becomes "a major problem for the investing public," Mr. Marchman said. The National Association of Securities Dealers and the Securities and Exchange Commission are also looking at these types of trades. Lawyers at Wall Street firms have been requesting guidance on when it is acceptable to trade, said Stephen Luparello, the NASD's executive vice president for market regulation. The NYSE review began in March 2004 after the United Kingdom's Financial Services Authority fined Deutsche Bank AG's Morgan Grenfell securities unit for conducting trades that the FSA found had harmed a client by pushing the price of a stock up before the client could execute its order to buy. The client had requested a blind bid, and Morgan Grenfell was able to figure out some of the securities that were involved. Deutsche Bank said in December that it "takes its obligations to its customers very seriously and therefore regrets the misunderstanding with an experienced institutional customer." Some Wall Street firms point out that trading in front of client program orders can be a legitimate form of hedging. In one example, if a brokerage firm knows it is going to sell a large block of stock to a fund manager at the end of the trading day, it makes sense that the brokerage firm would buy shares for its own inventory to have enough shares to sell to the client. The tricky part is that buying in anticipation of a customer trade can push the price up, something that the NYSE says should be disclosed to investors. Some firms such as UBS AG say they don't trade in front of blind bids, in which clients may tip their hand about their intentions. Others such as Goldman Sachs Group Inc. and Deutsche Bank have said that they may trade on such information, but the practice helps them offer customers better trading prices. A Goldman spokesman said yesterday that the firm won't trade in such a way if a client instructs it not to. He added that the recommended approach in the NYSE letter "largely reflects our practices." Some money-management firms such as Barclays Global Investors have warned brokers not to trade on information they provide about their plans. The NYSE's letter was "sorely needed," said Michael Sobel, head of U.S. stock trading at Barclays Global. It reminds a brokerage firm that it has "an obligation to put customer interests ahead of its own pecuniary considerations." VWAP trades have grown in popularity because they allow fund managers to buy or sell at prices that look reasonable, at least on average. Investors who place such orders, however, run the risk that the Wall Street firms will have minutes or hours to trade in a way that pushes the average price around to their detriment. (END) Dow Jones Newswires August 04, 2005 04:00 ET (08:00 GMT) Copyright (c) 2005 Dow Jones & Company, Inc.