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Barbara Whelehan writes Boomer Bucks for Bankrate.com

Assessing Wall Street scandals

When you think about Wall Street, what sort of images come to mind? Do you imagine upscale financial centers in which genteel men and women dressed in pinstripe suits conduct commerce with a common purpose -- to serve the greater capitalistic good? Or do you think of urban blight, of grimy, littered back streets peopled by gangs, pimps and prostitutes who more openly exemplify the moral code that everyone is out for themselves?

Or is it some combination of these two images?

Wall Street may appear to be a place where business is conducted properly, where the interests of investors are always top of mind. But there are a lot of shenanigans going on behind the scenes that we can glimpse in the financial press. And then, after reading about them, we either feel the need to take a long shower or the desire to inhale toxic tobacco fumes while drowning our sorrows at the local pub.

OK, maybe we all don't have the same reactions. But we should, from time to time, assess the crime in our streets, whether it's the hush-hush white-collar variety of Wall Street or the whatcha-gonna-do-when-they-come-for-you-bad-boy, blue-collar, "Cops" version. And, we might try to answer the question, "How bad is this crime from an ethical perspective?"

Specialists in the NYSE
Let's take a look at the allegations of improper trading among specialists at the New York Stock Exchange. First, some background about what these traders actually do.

Specialists are market makers, middlemen actually, who are assigned particular stocks in which they trade. Their purpose is to keep an orderly flow of prices on the trading floor by matching up buyers and sellers. You can see them on CNBC, yelling and screaming at the tops of their lungs. You thought that was chaos? No, that was order.

They must make trades to facilitate these transactions, and they make money in the process. Specialists profit on the spread between the bid and ask price of a security, which is the difference between its purchase and sale prices. They also get money from dividends and interest earned on the securities they own, and they realize capital appreciation from securities they sell.

These are the lawful ways that specialists can make money to fulfill their profound responsibility: They must buy and sell securities in all market conditions, and they bear the risk of loss from unexpected price drops. A textbook on investments describes their role this way: "These market makers guarantee to buy and sell at the prices they announce. Thus, an investor knows what the securities are worth at any given time and is assured that there is a place to sell current security holdings or to purchase additional securities. For this service, the market makers must be compensated. ..."

Saintly specialists
In fact, it is in the specialist's job description to trade against the grain of the market, buying when stocks are getting trashed and selling as they scale new heights, risking their capital in the process, all for the altruistic purpose of putting their brokerage customers (and ultimately you) first, above their own interests.

In other words, their actions are ostensibly selfless. These specialists should be canonized as stock market saints.

Except that they're human beings who succumb to temptation. Being privy to the imminent direction of stocks in the market puts them in a unique position to exploit that information for selfish gain. And recently they've gotten into trouble for doing just that -- more about that in a minute.

Superfluous specialists
First, let's explore their role in the scheme of things. Are they necessary parts of the market machinery or are they an encumbrance, a wrench in the works?

"NYSE floor traders can be replaced by a computer -- literally," says Gary Weiss in his book, "Wall Street Versus America: The Rampant Greed and Dishonesty that Imperil Your Investments."

Next: "So how did the aforementioned specialists get into trouble?"
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