FIVE KINDS OF INSIDERS

THE SEC's second look at the nation's 14 stock exchanges concentrates on the role of a largely anonymous but highly influential army of "inside" professionals. The 65 reforms proposed in the SEC report center on five types of these market insiders, whose functions affect all investors but are rarely understood by the public. The five:

Over-the-Counter Traders

These men deal in the issues of 11,000 companies that are not listed on any exchange. Unlisted issues are often the sharply curving "glamour" stocks, but they also include some solid shares of major companies that do not wish to be bound by the exchanges' strict reporting rules. Over-the-counter trading has increased 700% since World War II, and accounted for roughly 38% of the $103 billion worth of stock sales in 1961. Some 1,100 stock wholesalers operate in the O-T-C market. When a broker places an order for a customer, the wholesaler either draws the unlisted stock from his own portfolio (each wholesaler "makes markets" in several issues), or telephones around to others to dicker for a deal. Since there is no clearing house, no ticker tape and scant supervision, ample room exists for imaginative wheeling and dealing.

Odd-Lot Traders

They handle the small investors' orders for lots of fewer than 100 shares. Odd-lot trading makes up 9% of the volume on the New York Stock Exchange, and 99% of all these transactions are handled by two firms: Carlisle & Jacquelin and DeCoppett & Doremus. Brokers place their odd-lot orders with these two firms, which usually sell the shares from their own portfolios at the going market price, plus a fractional markup. Together, the two firms in 1961 earned $12 million on a gross of $35 million.

Stock Specialists

Each of these middlemen is assigned by the exchange to "specialize" in several stocks and stabilize their prices by buying when prices are falling sharply and selling when they are rising swiftly. On the New York Stock Exchange where they account for 30% of all transactions 353 specialists belong to 107 firms. Each firm usually handles 12 to 15 issues, though the biggest--Adler, Coleman &

Co.--has 45. To become a Big Board specialist, a man must pass three examinations, own a seat on the exchange (current price: $205,000), pay post rentals and fees of $1,300 to $6,300 a year. Specialists make about half their profits from commissions as floor brokers for other firms (average commission: $3.85 per 100 shares), and half by trading for their personal accounts. Specialists pay only tiny commissions on their personal trades, are allowed to buy on a low 25% margin v. 50% for others. They often buy a big block of shares one minute and sell it the next for a profit in fractions.

Short Sellers

Professional bears, they are usually big round-lot (100 shares or more) speculators who wager that the market will drop. They borrow stock through other brokers and sell it at, say, $10 a share, hoping to replace the borrowed shares later by buying them back at a lower price, perhaps $5. Their profit would thus be $5 a share. Anyone can sell short--Joseph P. Kennedy reportedly made a killing doing so in 1929--but it is a dangerous game, little suited to the fainthearted or the unsophisticated.

Floor Traders

The SEC calls this group "a vestige of the former 'private club' character of stock exchanges." Unlike specialists, who trade for both brokers and themselves in the few stocks in which they specialize, floor traders trade only for their own profit in any stocks they wish, roaming exchange floors freely and benefiting from inside information. Partly because few men any longer have either the wealth or inclination to work at it, only about 30 men are active floor traders on the New York Stock Exchange and 15 on the Amex, though any member of the New York Exchange who passes two examinations may so trade. Even the biggest of the floor-trader firms are little known to the public: E. H. Stern & Co., Price & Davis Co., Schiff & Co., and Pagan & Co. While floor trading amounts to only 2% of the exchange transactions, the SEC noted that in one recent period it accounted for a surprising 10% of the trading in volatile issues that fluctuated by one point or more a day.

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