NYSE and Merc Propose Market Reform Package : ‘Circuit Breakers’ Would Temporarily Halt Trading if Dow Index Falls Sharply

The New York Stock Exchange and Chicago Mercantile Exchange on Thursday proposed a collection of market reforms that include imposing coordinated trading halts-- “circuit breakers”--if stock prices begin to collapse as they did last October.

In what they described as a comprehensive reform package, the two big stock and futures exchanges proposed a one-year experiment during which trading in the two closely tied markets would be temporarily halted if the Dow Jones industrial index falls 250 points in a daily session.

The proposals now go to the Securities and Exchange Commission for approval.

The Big Board also said it will soon begin publicly disclosing the identities of program traders, whose computer-directed buying and selling has been blamed by some for worsening the crash. And as expected, the exchange said it will institute a new system for handling electronic buy and sell orders, which is intended to help small investors in turbulent markets.

Echoes Brady Commission

Also, as anticipated, the Big Board said it intends to phase out the trading “collar” that halted the computer-directed trading called index arbitrage through the exchange’s electronic order system on days when the Dow has moved 50 points. In index arbitrage, traders buy and sell huge blocks of stocks and futures contracts to profit on small price discrepancies between the two.

The proposals, worked out in five months of consultations between officials of the two exchanges, are clearly intended to answer calls from Washington and parts of the investment community for further action to restore shaken investor confidence. Circuit breakers were urged by the presidential study panel on the crash, called the Brady Commission, and echoed in the recommendations of a second White House-organized panel, called the Presidential Working Group.

“These steps are dramatic,” said Leo Melamed, chairman of the executive committee of the Merc. “And what is very important is that we did them in New York and Chicago, not in Washington.”

The Brady Commission and others have been calling for coordinated action by the two markets, which have become ever more intertwined in recent years as investors have traded huge blocks of stocks and the stock index futures contracts that are derived from stocks.

The circuit breaker proposal must still win the approval of other U.S. markets, the Securities and Exchange Commission and the Commodity Futures Trading Commission, which regulates the futures industry. But Melamed said in an interview that reaction from the regulators has been positive, and predicted approval would come within several weeks.

The exchanges’ joint proposal sets out complex rules for halting and resuming trading in stocks and futures if prices begin a drastic slide such as the one that happened last Oct. 19.

Under the plan, all Big Board trading would be halted for one hour if the Dow falls 250 points, and for two hours if the Dow falls an additional 150 points in the same day.

If the Standard & Poor’s contract falls 30 points as the Dow falls 250, trading in both markets would be halted for one hour. If trading resumes and the futures contract falls a further 20 points, futures trading would be halted for the remainder of the day, but the stock market would have the option of resuming trading after a two-hour halt.

The New York Stock Exchange has never imposed a complete trading halt, although halts are a longstanding feature of futures markets. Critics of such halts have argued that they may not stop a major slide, but rather hasten it by panicking investors who want to bail out of the market.

Will Disclose Data

A member of the NYSE board of directors, who asked to remain unidentified, said the circuit breaker would probably not stop a downward slide of prices if the market were shaken by severe economic news. But it might interrupt “the kind of self-feeding, cascading of prices that we saw in October,” he said. “It’s designed to interrupt that cycle.”

Starts This Month

The board member said that, in his opinion, the one-year pilot program is likely to run its course without being used. The circuit breaker proposal, he said, is “an acknowledgement of the political reality that we cannot let people think that October could come again without our putting in additional safeguards.”

The Big Board said it will this month begin disclosing data on program trading that it has been collecting from member firms. Since May, the exchange has required member firms to submit information on program trades that they execute for customers and for their own accounts.

Under the proposed circuit breaker system, if stock prices begin a precipitous slide, program trading orders would be segregated into a special computer file to determine how much of an imbalance existed between buy and sell orders. The orders would be held up for five minutes before being reported to the Big Board specialists, who supervise trading on the exchange floor.

Trading would be halted for some stocks if the imbalance were too great, and the size of the imbalance would be publicly disclosed. Such special treatment for program-trading orders is intended to try to stabilize the market by giving all participants information on the flow of orders.

Equal Priority

The Big Board’s plan to give priority to individual investors’ orders would create a special “express line” for them that would put them ahead of the buy and sell orders of larger investors. Orders of 2,000 shares or less would be routed into this line on days when the market has moved 25 points or more.

Once the orders reach the specialist, however, they would be given equal priority with larger orders.

The exchange’s proposals were released late in the day, and reaction from the investment community was incomplete. In statements, however, two big investment firms, Shearson Lehman Hutton and Kidder, Peabody & Co., praised the exchanges’ efforts to restore confidence in the markets.