“The New York Stock Exchange, in a probe of possible abuses of a central part of its trading system, is examining whether at least two of the largest floor-trading firms may have engaged in ‘front-running,’ or trading ahead of clients, according to people familiar with the matter,’ writes Kate Kelly in today’s Wall Street Journal.

“The world’s leading stock exchange in recent months has been seeking information from ‘specialist’ firms about whether their traders may have mishandled customer orders, the people said. Specifically, the NYSE is examining whether the specialist firms, whose floor traders carry out clients’ transactions, have offered inferior prices to investors who send orders to buy or sell shares through the exchange’s main trading system, the people said.”

“The inquiry is focused on at least two of Wall Street’s biggest names: FleetBoston Financial Corp.’s Fleet Specialist subsidiary and LaBranche & Co. The NYSE has seven specialist firms.”

“The probe already has had an impact on the NYSE’s trading floor. On Monday, Fleet Specialist’s chief executive, Christopher Quick — who also is an NYSE director — suspended David Finnerty, who handles Fleet’s trading for General Electric Co. stock. The suspension stemmed from an internal Fleet investigation prompted by the broader NYSE probe. Fleet is examining whether the 37-year-old Mr. Finnerty traded ahead of customer orders in GE, people familiar with the inquiry said. GE, with $276.9 billion in stock outstanding, has the world’s biggest stock-market capitalization. It’s not clear how much money would have been involved in any alleged front-running, or how many of the specialists’ clients might have been affected.”

” ‘This is an internal Fleet matter that we’re currently handling,’ said James Mahoney, a FleetBoston spokesman. An NYSE spokesman, citing Big Board policy, would neither confirm nor deny that any probe was taking place. GE declined to comment.”

“Mr. Finnerty didn’t return messages left at his New Jersey home, and Mr. Quick declined to comment beyond FleetBoston’s statement. Officials at LaBranche had no comment.”

“If evidence of wrongdoing emerges, those revelations would be particularly sensitive for the Big Board because such activity could undermine public trust in the auction market, the central way shares are traded on the exchange. The auction market, the exchange’s model for the last 211 years, consists of traders gathering at the exchange’s Wall Street trading floor to physically barter for shares of stock. Although myriad improvements have been made on the system over the years, including the introduction of a computer that ferries stock orders to and from the floor, the core aspect of the auction model is still the same: Brokers wanting to buy and sell shares of stock gather in front of a trader, or ‘specialist,’ who is assigned to keep the trading fair and orderly in a particular stock.”

“The Big Board’s specialists oversee the trading of some 2,800 stocks. In order to match customers’ orders, specialists are required to buy shares for their accounts at times and sell shares from their inventory at other times. While they earn money from commissions for handling orders, specialists also can make — or lose — money from the trading of stocks held in their accounts, depending on whether prices are moving higher or lower.”

“Front-running is the exchange equivalent of waiting in line at a lunch counter and having a bully cut in front to order. Here’s how front-running works in its most basic form: An investor places an order to buy 10,000 shares of a stock. Recognizing that the trade is likely to boost the value of the shares, a broker trades for himself or a partner before completing the client’s order. In some cases, a front-runner could buy the shares and then flip them, at a higher price, to the investor he or she is trading ahead of. The result is doubly problematic: It can make the client order more expensive to fill — taking money out of the customer’s pocket — and it unfairly enriches the broker.”