5 Brokerages Suspend Own Program Trades : Firms to Continue Using Controversial Technique for Clients’ Accounts
Five of the biggest practitioners of program trading, the computerized activity blamed for aggravating stock market volatility and the October crash, said Tuesday that they will suspend the controversial practice for their own accounts.
The voluntary moves, made to restore investor confidence and assuage a growing chorus of critics, all but eliminated for now the last of the major Wall Street firms conducting program trades for their own accounts.
The moves also follow recent actions by the New York Stock Exchange to increase controls on program trading, amid critics’ concerns that the activity is getting out of hand, exerting a greater influence on market movements and possibly leading to market manipulation.
However, some Wall Street experts said the profitable practice will continue to influence the market, because an increasing amount of the activity--perhaps more than half--is now being done for clients, generally large government and corporate pension funds seeking steady returns with relatively little risk.
Four of the five firms--Salomon Bros., Morgan Stanley & Co., Paine Webber Inc. and Kidder, Peabody & Co.--said they will continue to conduct program trades for clients. Only one, Bear, Stearns & Co., said it suspended the activity for clients as well. And all said their suspensions were temporary, leaving open the possibility of future reinstatement.
“This will not have that much of an impact immediately,” said Perrin Long, brokerage industry analyst for Lipper Analytical Securities in New York. If there is another big market move that appears to be caused by program trading, blame may be focused on clients, he said. They now largely function anonymously, in some cases hiding their identities by trading through large New York banks.
Index Arbitrage Stopped
“The fat lady hasn’t sung yet. Voluntary absence from program trading is not the answer,” said Robert W. Nichols, president of RNC Capital Management in Los Angeles and a leading critic of program trading, adding that big pension funds and foundations will continue to engage in the practice.
The five firms join Merrill Lynch, Prudential-Bache Securities, Goldman Sachs, First Boston and Shearson Lehman Hutton, among others, that have announced since the crash that they would discontinue the variation of program trading known as index arbitrage.
That variation, the most popular form of program trading, involves trying to profit from price discrepancies between stocks traded in New York and futures on such stock indexes as the Standard & Poor’s 500, traded in Chicago. Program traders simultaneously buy stocks and sell futures, or vice versa, in massive blocks.
Despite moves by Wall Street firms to curb the practice for their own accounts, program trading appears to have even greater influence on market movements, in part because volume from conventional trading has slowed considerably and because program trading has become more aggressive, with some traders trying to profit by anticipating moves of other program traders.
On days when program trading is active, it accounts for as much as 30% of overall volume on the Big Board, considerably higher than before the crash, said Jack Barbanel, director of futures trading for Gruntal & Co. in New York. The practice has been blamed for aggravating such big post-crash movements as the 101-point plunge in the Dow Jones industrial average April 14 and the 140-point dive Jan. 8.
It also has been blamed for driving many institutional and individual investors to the sidelines while discouraging some corporations from issuing new stock.
That continuing volatility in part prompted the NYSE last week to require member firms to submit data on all program trades within 48 hours of the transactions. The Big Board also cuts off access to its automated order execution system, used for program trades, when the Dow rises or falls more than 50 points from the previous day’s close.
Both rules, coming amid reduced overall volume, make program trading more expensive and time-consuming but won’t eliminate it, experts say.
‘Subterfuge’ Created
In announcing their cutbacks in program trading, the five firms on Tuesday defended the practice, saying it has promoted efficiency by linking the stock and futures markets. The firms implied that they were curtailing index arbitrage only because of the growing criticism and to avoid possible unwanted regulation.
“I happen to think it (index arbitrage) is good for everybody. It gives liquidity to the markets,” Alan C. Greenberg, chairman and chief executive of Bear Stearns, said in an interview. Critics who contend that it disrupts the markets “don’t know their ass from first base,” he said.
“But if you are going to quit, why create a subterfuge by stopping it for your own account while continuing to do it for clients?” Greenberg added in explaining why his firm went beyond its competitors and suspended the practice for clients as well. Bear Stearns said it hasn’t participated in index arbitrage since last Thursday.
“The current emotional, often self-serving arguments (against) program trading have not produced constructive dialogue on the structural reforms necessary for these markets,” Kidder Peabody President Max C. Chapman Jr. said in a statement.
“The ceasing of this activity by Salomon and others is not the answer to volatility in the marketplace,” Salomon Bros. Chairman and Chief Executive John H. Gutfreund said in a statement. Instead, he said, the basic market structure must be addressed “so that the futures and equity markets can coexist.”
The moves are likely to have only a minimal impact on the firms’ revenues but could reduce pretax profits for bigger players such as Salomon Bros. and Morgan Stanley by as much as 10% to 20%, in part because of slumping profits from other activities, analyst Long said. Some sources say program trading recently has accounted for all of Salomon’s equity trading profits.
Salomon Bros. said its proprietary index arbitrage business accounted for less than 0.2% of its revenue, while Morgan Stanley said it accounted for about 0.5% of its first-quarter revenue.
