3 Major Brokerages to Curb Program Trading Activity
Some of Wall Street’s biggest firms are backing off from a form of computerized trading that is widely blamed for making the stock market more volatile.
The strongest backlash against computer-driven “program trading” came Friday, when three of the best-known brokerages--Morgan Stanley & Co., Bear, Stearns & Co. and Oppenheimer & Co.--said they will stop using the technique, at least temporarily, when buying and selling securities with their own money. The firms said they would still engage in program trading for their clients.
At least one major brokerage, Paine Webber Group, said earlier this week that it will stop program trading on behalf of its clients as well--expanding a policy set in May, 1988, that barred such trading for the firm’s own account.
In addition, the New York Stock Exchange has begun to review its policy on program trading.
Criticism of program trading among the investing public and some Wall Street professionals has picked up dramatically since the Dow Jones industrial average lost 190 points on Oct. 13. The plunge evoked painful memories of the 508-point crash on Oct. 19, 1987, which also brought widespread controversy to program trading.
Since the dramatic drop in stock prices two weeks ago, the markets have had a number of wild days, moving up and down as much as 85 points in a day. Stockbrokers and some financial companies have said that the volatility is driving many investors out of the market.
The decision by Morgan Stanley, Bear Stearns and Oppenheimer to suspend program trading for their own accounts was apparently influenced by Kemper Financial Services, a large Chicago-based money management concern that has long been critical of the strategy. Earlier this week, Kemper turned its criticism into action, informing the firms--and one other, Kidder, Peabody & Co.--that Kemper would stop using their brokerage services to protest their continued use of program trading for themselves. Phoenix Mutual Life Insurance Co. of Hartford, Conn., announced a similar policy Friday.
Unlike the other three program traders, Kidder did not announce any action Friday. A Kidder spokesman refused to say if any change in policy is under consideration.
The form of program trading at issue is known as stock index arbitrage, in which rapid-fire computer programs simultaneously buy and sell large quantities of futures contracts for “baskets” of stocks--known as stock index futures--and the stocks themselves.
The purpose is to lock in profits by exploiting temporary price differences between the futures and the underlying stocks. The strategy is most profitable when the market is already moving sharply higher or lower anyway, since price differences between the futures and the stocks are largest then. This often sets off a chain reaction that makes the price swings even greater.
According to the NYSE statistics, Morgan Stanley, Bear Stearns and Kidder were among September’s top four program traders engaging in index arbitrage. Together, the three firms traded 107 million shares that month through the computerized trading strategy, while Oppenheimer ranked considerably lower. Program trading, in general, accounted for a record 13.8% of NYSE volume in September.
In announcing Kemper’s protest action Wednesday, Stephen Timbers, the firm’s chief investment officer, said in a statement that “in the present environment, index arbitrage generally increases intra-day market price volatility, which undermines investors’ confidence in the fair functioning of the markets.”
In a telephone interview Friday, Timbers said he believed that the three firms’ decision to halt program trading for themselves came in response not only to Kemper’s de facto boycott but to a “groundswell” of protests from the firms’ own stockbrokers. Retail brokers have said that the market swings caused by program trading are driving away their customers.
Now that the three firms have given in, Kemper will resume using their brokerage services, a Kemper spokesman said.
James E. Cayne, president of Bear Stearns, said the firm decided to halt its own program trading because “a lot of major clients of ours feel it’s something they don’t think we should do.” He said the firm will wait to see what steps regulators or Congress may take to boost market stability before the firm decides if it will resume the program trading.
Reached by phone on Friday, Richard A. Grasso, president of the NYSE, said that the exchange plans to have discussions with its member brokerage firms, as well as companies whose stock is listed on the exchange and a variety of investors. He said the purpose is to determine if any new steps should be taken to control program trading. Grasso said the exchange is “clearly concerned about the public’s confidence in the mechanisms” of the stock market.
The steps taken on program trading came as the market appeared to be in a sustained slide. The Dow industrial average fell every day this week, closing Friday at 2,596.72, down 92.42 points for the week.
Goldman, Sachs & Co., another major investment bank, said Thursday that it will lobby the exchanges to impose additional limits on program trading. Goldman Sachs stopped doing program trading for its own account after the 1987 crash, but it still does it for customers. Dean Witter Reynolds, another brokerage firm that abandoned the strategy earlier this year, on Friday sent a letter that was critical of program trading to more than 2 million clients.
