Here are some interesting stories for now.
From Our Archives
Living Off The Spread
Richard L. Stern, 07.10.89, 06:00 PM EDT
Bernie Madoff pays brokers for the privilege of executing their orders. How can this be? He is taking advantage of an obsolete New York Stock Exchange rule that protects specialists at the expense of everybody else
On a recent weekday tourists waited more than 90 minutes to get into the New York Stock Exchange visitors' gallery for a glimpse into the inner workings of the American capitalist system. One elderly visitor was explaining to his young grandson that somewhere in the noisy bustle below them, grandpa's gift of 100 shares of AT&T; had been filled.
Not necessarily, Grandpa. in today's stock trading, things are seldom what they seem.
As things now work, an order to buy or sell New York Stock Exchange-listed securities may or may not be executed there. it may instead be executed on a regional exchange. Or it may never have gone to an exchange floor at all but to a small midtown Manhattan firm called Bernard L. Madoff investment Securities, which is not a member of the exchange but nevertheless makes markets in the Big Board's 250 biggest-trading stocks.
Why should stock exchange members deal with Bernie Madoff instead of with each other? Simple. it's often cheaper to execute the customer's order through Madoff than on the floor of an exchange.
Madoff won't say which firms are sending him orders. This is a sensitive area because his customers don't want to offend the Big Board or its specialists. But over 100 member firms are doing business with Madoff. These include A. G. Edwards & Co., Minneapolis-based Dain Bosworth, Texas' Rauscher Pierce Refsnes and--especially--big discounters like Charles Schwab (nasdaq: SCHW - news - people ) & Co., Quick & Reilly and Fidelity Broker-age Services.
Each morning, Bernie Madoff's 20 traders sit in front of computer screens on the 18th floor of a mid-town Manhattan office building. When they go home in the evening, the 20 will have handled execution of about 2% of the volume in NYSE-listed stock--sometimes as many as 5 million shares.
Why do brokers deal with Bernie Madoff? Simple. He saves them money. Not only does he not charge the usual specialists' commissions and Big Board fees, but he will often pay the brokers a small fee for the privilege of executing their orders as well.
It's very simple. Bernie Madoff [runs a ponzi scheme]
lives off the spread between bid and asked, a spread that usually amounts to one-eighth of a point on shares of the most liquid stocks.
Does the broker's customer get a raw deal when orders go to Madoff? [Hell yes!]
Probably not. Madoff guarantees to buy or sell orders of up to 3,000 shares at the best price quoted among the New York and regional ex-changes. That's the best "bid" when a customer is selling and the best "ask" when a customer is buying. Moreover, Madoff's guarantee of 3,000 shares is frequently larger than what Big Board specialists are willing to guarantee.
Bernie Madoff, 51, has gotten very rich
living off the spread [running his ponzi scheme]. He grew up in a middle-class section of the New York City Borough of Queens and never quite finished Brooklyn Law School. He won't say how much his firm makes, but the word is that despite hard times on The Street, Madoff is very profitable. During the last few years, even though the tough years of 1987 and 1988, he added about $8 million a year to the firm's capital position--which recently was $50 million, according to Security & Exchange Commission documents.
The computer executions lower Madoff's costs, of course. But Madoff's computer operation is far more sophisticated than one designed solely to cut handling costs. A key to profitability in marketmaking is the ability to hedge positions, Madoff explains. Once the computer has that iBM stock it just bought, it shows the trader various ways of hedging his position and the costs. it even shows the carrying costs for not hedging. That hedging is done by Peter Madoff's software system. The Madoffs' computer hedging is far ahead of anything that the specialists have.
Why can't member firms simply make markets for their customers in listed securities, as Madoff does? The New York Stock Exchange won't let them. The Big Board protects a kind of monopoly by its specialists through the NYSE Rule 390. This essentially prevents most Big Board members from making markets for their own accounts in most NYSE-listed securities. That forces the members to bring orders either to the New York floor, to another exchange or to someone like Madoff.
Madoff saw opportunity in this rule in the mid-1970s through the Cincinnati Stock Exchange a near-defunct attempt to create a fully electronic, computerized stock exchange. Madoff spent over $ 250,000 up-grading Cincinnati's computers and began making markets in listed stocks.
The advantage of Cincinnati for Madoff is that, as an accredited exchange, it allows him to participate in an intermarket trading system put into place in the late 1970s at the insistence of the SEC to lessen New York's monopoly on the nation's biggest stocks.
Bernie Madoff is very much aware that his own monopoly won't last forever. Deregulation is everywhere in the air, and the Big Board monopoly via Rule 390 will one day cease.
At least two congressional agencies currently are investigating whether the rule violates congressional mandates for a national market system that would be more efficient and fairer to investors.
One day, probably sooner rather than later, there will be a nationwide computerized system that, with luck, will preserve the present exchange auction system, which allows customer orders to meet within the spread. it will also eliminate specialists and floor brokers and let buying broker and selling broker meet with-out intermediary. The technology is not new or difficult. The New York Stock Exchange has been a major hindrance. Bernie Madoff just has the first fully automated firm to show brokers the economic benefits of getting rid of Rule 390.
First published in FORBES magazine, issue dated Jul. 10, 1989.
Bank Reform Hits Snag
Pittsburgh Post-Gazette - Google News Archive - Mar 1, 1979
WASHINGTON AP — The Carter administration, normally an advocate of government reorganization, reversed roles yesterday and opposed a Senate bill that would consolidate the nation' s disjointed system of bank regulation.
Sen. William Proxmire D-Wis., one of the bills sponsors, said he was deeply disappointed by the administration' s position, noting that reorganizing the bureaucracy had been one of President Carters “cardinal principles”
However, Robert Carswell deputy secretary of the treasury, said the administration feels that overhauling banking regulation at this time would hurt other efforts to improve the nation' s banking system. [What exactly are these “other efforts”?]
Proxmire's bill would establish a single five-member commission to regulate the nation's financial institutions, replacing the three agencies that currently administer federal banking laws.
Proxmire said the existing system of regulation creates inconsistency in the enforcement of banking laws and permits banks to pick their own regulating agency — a situation that allows a bank to choose the agency that is most lax in enforcing the laws.
“I don' t think there has ever been an industry regulated the way the banking industry has been” said Proxmire, chairman of the Senate Banking Committee, “It' s incredible”
New form of hedging gets the go-ahead
Milwaukee Journal - Google News Archive - Dec 8, 1981
Washington, D.C. —UPI— Government regulators cleared the way Monday for a new financial industry that will allow speculators a new world of risk-taking that goes beyond stocks, bonds and commodities — trading in statistics.
The Securities and Exchange Commission and the Commodity Futures Trading Commission announced that they would soon begin to authorize a new financial instrument that will allow traders to stake out positions in the major indexes of stock prices and interest rate fluctuations, such as the Standard and Poor' s 500 stock listing or a broad-based Value Line survey.
The instruments will provide investment bankers and portfolio managers ways to hedge themselves against their major adversaries — inflation and interest rate fluctuations — the same way farmers have been able to hedge against bad crop years on the commodity markets.
Commodity regulators OK sales of futures options
Anchorage Daily News - Google News Archive - Sep 25, 1982
NEW YORK — After wandering for more than four decades in an often bizarre legal and regulatory wilderness, the commodity industry will finally — this Friday — get to open markets in options based on futures. A three-year pilot program has been approved by government regulators.
The Chicago Board of Trade will start trading options Oct. 1 on its highly successful Treasury bond futures and New York' s Coffee. Sugar and Cocoa Exchange will trade options based on its world sugar futures. The following Monday, New York' s Commodity Exchange vill offer options on its gold futures.
The MidAmerica Commodity Exchange in Chicago is expected to open soon an options market on its 33.2-ounce gold futures contract. Comex' s standard options and futures are for 100-ounce contracts.
“What makes the introduction of commodity options so bizarre is that Congress in 1975 specifically set up the Commodity Futures Trading Commission for the purpose of regulating a legitimate market in these options,” said Thomas A. Russo, a partner in the Wall Street law firm of Cadwalader, Wickersham & Taft.
Russo is a specialist in commodity trading who played a large role in writing the first code of regulations for the Commodity Futures Trading Commission, which began operations in April, 1976.
Congress created the federal agency because thousands of investors were being gulled out of hundreds of millions of dollars at the time by unethical or simply crooked dealers in options ostensibly based on London commodity markets.
“Many investors found that the options they had bought on so-called London commodities were fraudulent; others made huge paper profits during the commodity price explosion of 1974-75 couldn' t find their dealers when they went to cash in,” Russo noted.
Meanwhile, licensed and regulated American commodity exchanges were prohibited from trading options because, and this was another strange twist, Congress had outlawed “privileges,” a form of options, during the New Deal days of the mid-1930s.
options on futures contracts.
Program To Open Friday
Exchanges Set To Trade in Futures Options
Toledo Blade - Google News Archive - Sep 27, 1982
CHICAGO (AP) The futures industry steps into uncharted territory Friday when four commodity exchanges begin trading in a new instrument — options on futures contracts.
The Chicago Board of Trade, for example, will be dealing in options on Treasury bond futures.
‘It' s a mouthful just to say, and it looks complex enough to make you cringe.” Thomas K Bonen, group manager for financial instruments at the Board of Trade, says.
But officials at the Board of Trade say they do not expect many traders to be put off by the new options
Richard Sandor, chairman of the options committee and chief economist at the exchange, says he thinks the new Treasury bond option could someday double the trading volume at the board. He says it will offer companies a way to guarantee interest rates in the future.