Program Trading Lives--Some Ask Why : Lifting of Ban by Big Board Delights Fans, Enrages Foes, Surprises All
Judging from Wall Street’s reaction, one might have thought New York Stock Exchange Chairman John J. Phelan was resurrecting the dead last Friday when, in fact, he was only lifting the 2-week-old strictures on computerized program trading.
“I had given it up for dead,” said a pleasantly surprised program trader at one of Wall Street’s largest investment houses. “At the very least, we were sure there would be so many restrictions that it would be an absolute waste of our time.”
Philip B. Erlanger was also “shocked as hell” by the Big Board’s “unbelievably irresponsible” decision. “It’s like giving a second chemistry set to a child after he blew up the first one,” said the chief technical analyst for the Advest investment firm in Hartford, Conn.
Program trading--which enables securities firms to make money by capitalizing on small price discrepancies between stock index futures and the underlying stocks that compose the index--has been flaring tempers ever since its introduction to the U.S. financial markets in 1982. But in the aftermath of charges by Phelan and others that it was a key perpetrator of last month’s stock market crash and Phelan’s subsequent surprise decision to lift all curbs on the controversial trading maneuver after less than two weeks, program trading is stirring controversy as never before.
Lobby With Clout
This time, it shares the spotlight with one of its most vocal critics--Phelan.
“Pressure was brought to bear” by some “very powerful firms that find program trading very profitable,” said veteran brokerage analyst Perrin Long with Lipper Analytical Services.
“This is a very powerful lobby you’re dealing with, and they didn’t like having their gold mine taken away,” said Michael Metz, a market strategist for Oppenheimer & Co. who described himself as “blinded with rage” by Phelan’s “astonishing” decision.
“Tongues are wagging that the New York Stock Exchange was threatened with a lawsuit” for overstepping its authority under federal securities laws, said the chief investment officer for a Wall Street firm that doesn’t engage in program trading.
These are widely held views in the financial markets but unsubstantiated ones. Phelan has declined to discuss his motivation. And the major program traders--Goldman Sachs, Morgan Stanley, Solomon Bros. and First Boston--either refuse to discuss the matter or deny having pressured or threatened exchange officials.
NYSE officials acknowledge that Phelan’s decision followed consultations with NYSE member firms, as well as with legislators investigating the role of program trading in the Oct. 19 crash and with executives of the nation’s futures exchanges, whose livelihoods were threatened by the prospect of program trading’s demise.
But the NYSE officials insist that the Big Board always intended to ease back to normalcy--both in terms of hours and allowing computerized program trades--once the market’s volume and volatility waned.
As for speculation that Phelan caved in to threats of a lawsuit, an NYSE spokeswoman said: “We never stopped anyone from using our automated order system; we only requested that they not use it. How could anyone build a (legal) case on that?”
Exchange officials also challenge critics’ charges that Phelan’s action was premature by noting that both program trading and the overall trading volume have been quite light after full-fledged program trading was permitted to resume.
Calls It Inhibiting
“It will be damned difficult for the (Reagan-appointed) Brady group to claim that program trading causes difficulties in the market if nothing happens now that program trading is back,” Long agreed. A commission headed by Dillon Read Chairman Nicholas Brady is investigating the market crash.
Metz, however, thinks people are “misgauging the impact” of resumed program trading. “I don’t see how anyone can argue that it isn’t profoundly inhibiting real investment by real investors,” he said.
Many market analysts believe that the trading volume has diminished this week because small investors are waiting on the sidelines--afraid that those securities firms that base their trading decisions strictly on a computer program increase the risk for small investors in a touchy market environment.
The latest saga in program trading’s short life began Oct. 19, when the Dow Jones industrial average took an unprecedented 508-point plunge and panic consumed the world financial markets.
Phelan and others immediately pointed a finger at program trading, which critics accuse of heightening market volatility. This charge stems from the fact that huge quantities of stocks are traded instantaneously through program trading, which in turn can intensify the magnitude of price swings.
Accounted for Heavy Share
As securities firms have committed ever greater resources to this business--about $20 billion is believed to have been committed to program trading last year--volatility has intensified. Phelan estimated last month that program trading now accounts for 15% of the daily volume on the Big Board on a typical day and has risen as high as 30%.
On the Friday before Black Monday, he said, program trading was responsible for more than 20% of the volume. And on Black Monday itself, the Commodity Futures Trading Commission said in a preliminary report issued this week, about 9% of the 604.4 million shares traded on the Big Board were program trades.
Hoping to calm panicked investors and reduce the volatility, Phelan immediately asked securities firms to refrain from using the exchange’s computerized trading system to execute their program trades. This effectively eliminated most program trading because few firms were willing to spend the time to write up thousands of order tickets needed to execute transactions that they could do with the push of a button under the exchange’s automated system.
Although Phelan never indicated how long these restrictions would continue, many assumed they would be permanent.
“At the very least, I thought they would keep the restrictions on until we got through the congressional hearings and the regulators finished their studies and reached some conclusions,” said Jack Barbanel, director of futures trading at Gruntal & Co. in New York.
Lucrative Business
The Securities and Exchange Commission, the Senate Banking Committee, a House subcommittee and the Brady commission all are investigating program trading’s role in the crash. In addition, former U.S. Atty. Gen. Nicholas DeB. Katzenbach plans to complete early next month a study on program trading commissioned by the NYSE last March.
Others consider it naive to think that the securities firms active in program trading would have continued to voluntarily refrain much longer from such a lucrative business. In an interview last year, one program trader--Eric Seff, the investment manager for Chase Manhattan’s investment subsidiary--called program trading “the closest thing to making money without working I’ve ever found.”
“This is business that the exchange should turn away but business that obviously was too hard for them to turn away--especially in a market that is still very thin,” observed Hal Marlow, president of Market Timing Associates of Largo, Fla.
Added Barbanel of Gruntal: “The only ones with substantial sums of money and a commitment to the market right now are the programs. I don’t think we should have them at all, and I think some of the top NYSE people agree with that, but I also think they felt the need to create more liquidity in this market.”
Supporters of program trading say that once Phelan was shown evidence that program trading was relatively light on Black Monday, he quickly moved to lift the restrictions.
“If I thought for a moment that it accounted for 50% or 60% of the volume, I would be concerned, too, but it is only responsible for 10% to 15%,” declared William J. Breck, an executive vice president at Shearson Lehman Bros. “It was just the scapegoat.”
