SEC Study Says Market Has Become Even More Volatile Since the Crash in October
The stock market has become even more volatile and risky since the October crash, with trading increasingly dominated by huge institutional investors, a Securities and Exchange Commission study said Tuesday, and more individual investors could be scared out of the market unless changes are made.
In a 900-page report, the commission’s staff said it was still unable to say precisely what caused the Dow Jones industrial index to plunge 508 points on Oct. 19 and to continue swinging wildly in the following weeks.
One basic factor, it said, was a realization by traders that stocks were overvalued. And the SEC analysts agreed with the findings of a presidential commission early last month that futures trading and computer trading systems contributed substantially to the suddenness of the plunge.
Since the crash, the report said, trading of huge blocks of shares by institutions has accounted for a growing proportion of buying and selling, heightening risks for small investors whose participation in the market is considered by the SEC staff to be good for the economy.
“We are not sanguine that such participation will remain if price volatility akin to Oct. 19 occurs on even an occasional basis,” it asserted.
The report suggested that regulators and the stock exchanges consider increasing the size of the down payments that investors must make when buying stock and boosting the amount of capital some brokers must have on hand.
It also raised the possibility of increasing the markets’ capacity to handle an onslaught of orders and of establishing new specialists’ posts at the exchanges to help cope with institutions’ computer program trading.
“The October market break did not result in merely a dramatic one-time reevaluation of securities markets,” the study said. The volatility, if allowed to continue unchecked, “can have long-term, profound impacts on the participation of individual investors.”
The staff’s suggestions, designed to curb some risky stock transactions and dampen landslide selloffs, were relatively restrained. Commission Chairman David S. Ruder is expected to provide further recommendations today in testimony before the Senate Banking Committee.
The SEC report is likely to heighten the debate in Congress and in the securities industry over what to do in response to the October crash. The presidential commission, headed by Nicholas F. Brady, chairman of Dillon, Read & Co., has taken an aggressive stance, calling for the use of so-called circuit breakers such as temporary trading halts during periods of turmoil in the markets.
Congress’ General Accounting Office, which unveiled its own study recently, called on federal regulators and the exchanges to develop detailed plans to respond to future rapid collapses.
Congressional strategists say it still is not clear what Congress will do in response to the crash. Several lawmakers have proposed legislation to tighten securities requirements and oversight, but no one bill appears to have mustered enough support for passage.
Rep. John Dingell (D-Mich.), chairman of the House Energy and Commerce Committee, welcomed the SEC report as “a thorough, thoughtful document.” But he said the study showed as well that there could be “no easy solution or quick fix” through congressional action.
The SEC study, while aiming to curb volatility, did not prescribe a specific way to counter the increasing dominance of the market by institutional traders, who can have a sharp effect on the market when they trade huge blocks of stock instantaneously by computer. But it did warn that failure to address the range of factors that cause market changes could prompt small investors to flee from stocks.
A spokesman for New York Stock Exchange Chairman John J. Phelan Jr. said that “we generally agree” with the SEC staff’s recommendations.
The SEC report balked at two recommendations made by the presidential commission three weeks ago. It did not endorse giving the Federal Reserve sweeping authority to regulate the stock and futures markets, and it opposed setting federal limits on how far futures prices may swing. It said such measures would be unworkable and excessive.
The report also disclosed that the largest proportion of complaints filed by investors since the crash--about 43%--involved alleged failures by brokers to carry out orders to buy or sell. The staff recommended strengthening current regulations to require brokers to confirm completion of such orders so that investors would be alerted to problems if they receive no confirmation.
The document was particularly critical of the over-the-counter market, which it said was rife with unreliable quotations, delayed transaction reports and other problems that “undermined the liquidity and orderliness of the OTC market.”
The report also strongly disputed rumors that part of the slide stemmed from moves by foreign investors to abandon the U.S. market after the Dow industrials began to plunge. “The staff has not found evidence to support this belief,” it said.