Boyd L. Jefferies' admission that he illegally "parked" stock for Ivan F. Boesky not only gives new dimension to the insider trading scandal on Wall Street, it also raises serious questions about the way big-block trading generally is affecting the stock market.
There has been concern for some time that the growing domination of trading by big institutional investors and the rapid pace at which huge blocks of stock change hands on and off the stock exchanges could damage the fairness of the market. In short, the question is whether it has produced a market where the professionals have too much advantage over the general public, too much information on which to act before other investors know what is going on.
To handle big trades, investment banking firms must have considerable knowledge about buying and selling plans of big institutional customers. Policing what they do with this information is difficult.
In the past, the stock exchanges could handle much of the policing. That is no longer the case because so many of the big trades are made away from the exchanges. Moreover, any effort by the exchanges to tighten regulation on their own simply drives more of the trading activity away from them.
The Jefferies case makes real the worst fears--that individuals in the investment banking field would use their inside position to actively defraud the general public. Jefferies has admitted to artificially supporting the price of stock.
The case may be an isolated one, but there has to be suspicion, with the temptation so great, that Jefferies is only the tip of the iceberg.
The case makes it clear that trading abuses involving corporate takeover activities, the central concern raised initially by the insider trading scandal, are only part of the problem. What is needed to restore confidence in the market is a broad overhaul of market regulation to slow down the big-block trading activity, much of which is inanely uneconomic.
Changes in Investing Pattern
What has produced this vast change in the market is the way institutional investing has developed over the past two decades.
These investors, made up primarily of bank trust departments, insurance companies, mutual funds and pension funds, used to invest for the long term, changing holdings with some reluctance.
As the money flowing into these funds increased, competition developed among the investment advisers of these funds. They began turning over their holdings as much as 100% or more a year in search of higher returns.
Never mind that the long-term result of this competition often has been more commissions and other money management costs rather than real capital gains; the competition continues unabated.
Institutional trading now accounts for the major share of trading activity, producing daily trading volumes 20 times what they were in the 1950s and 1960s.
With computers, handling such volume has become possible. But what hasn't been resolved is how to keep that trading pace, dominated so heavily by the big investors, from skewing stock prices and putting the general investor at a distinct disadvantage.
It means the market is prone to far larger price fluctuations and raises the possibility of a major collapse should the big traders turn bearish and find no one to buy their holdings. In short, for all the activity, the market is operating with too few participants.
How can Congress deal with this?
In several ways. It can write new rules about the obligations of institutional traders to inform the public of their trading intentions. It can impose tougher fiduciary standards on investment fund managers that make the churning of stocks evidence of poor judgment.
It can require that trading activity in listed stocks be conducted on the exchanges, giving those bodies more power to enforce rules of ethics. It would impose more control on an outfit like Jefferies.
All of this is long overdue. The U.S. stock market has been the envy of the world, not only for the way in which it has supported economic growth but also for its fairness and proper regulation.
That reputation is being put to a severe test at the moment. Congressional action should be welcomed by all concerned.