Specialist: What it Means, How it Works, Roles

What Is a Specialist?

At one time, a specialist was the term used by the New York Stock Exchange (NYSE) to refer to a member of the exchange who acted as the market maker to facilitate the trading of a given stock. The NYSE now refers to these individuals as designated market makers (DMM).

Understanding a Specialist

The specialist's duties in the past were very similar to the duties performed by today's designated market maker (DMM) on the New York Stock Exchange (NYSE). A specialist held an inventory of a particular stock, posted the bid and ask prices, managed limit orders, and executed trades. If there was a large shift in demand on the buy or sell side, the specialist stepped in and sold off their own inventory as a way to manage large movements and to meet the demand until the gap between supply and demand narrowed.

Most specialists traded five to 10 stocks at a time on any given trading day. There was usually one specialist per stock who stood ready to step in and buy or sell as many shares as needed to ensure a fair and orderly market in that security. Each specialist had a particular spot on the floor of the exchange, called a trading post, where the buying and selling of stock occurred. Floor traders, who acted on behalf of customers who bought and sold the stock, gathered around a specialist's trading post to learn the best bid and ask offers for a security or a stock. Specialists executed a trade when bid and ask orders matched.

Specialist Roles

Specialists also would buy or sell the stock for their own account when it reached a certain price. If a floor trader's bid was far below the ask price, but then the gap narrowed to a more favorable level, the specialist could fill the order.

Before the stock market opened for the trading day, specialists also attempted to find a fair opening price for a stock in what was known as the opening rotation. If a specialist couldn't find a fair opening price, they might delay trading on a particular stock as part of their overall role.

Specialists had other major roles to fill. Specialists acted as auctioneers to show brokers the best bids and offers. Specialists also continually updated floor brokers to act as a catalyst for buying and selling. They placed orders on behalf of brokers and placed orders for customers ahead of their own. Despite all of these duties, the number of specialists declined over time, thanks to electronic trading.

Special Considerations

At one time, a handful of prominent specialist firms in New York employed the majority of the specialists on the floor of the NYSE. These firms wielded enormous influence on trading activities, causing some critics to question the amount of oversight these powerful firms received.

On March 30, 2004, the U.S. Securities and Exchange Commission (SEC) announced it had reached a settlement with five NYSE specialist firms for violating federal securities laws. The NYSE and SEC investigated the five specialist firms and found that between 1999 and 2003 the firms had violated federal securities laws by executing dealer account orders ahead of public customer orders.

Through this conduct, the firms unlawfully profited from trading opportunities at the expense of their public customers. The complaint said the firms breached their duty to serve as agents for their public customer orders. In many cases, public customers received inferior fill prices or their orders were never filled at all.

While the five firms neither admitted nor denied the allegations, the settlement required them to pay more than $240 million in penalties and disgorgement. The firms also agreed to implement actions to improve their compliance systems and procedures.