Is the SEC Surrendering Its Birthright? : Regulation: A proposed rule change undermines the agency’s ability to preserve free access to trading information. It’s a boon for institutions, a loss for small investors.
On the evening of Oct. 13, the day that the roof fell in on the stock market, Times reporters tried to find out what business had been done on the crossing Network. This is a service owned and operated by Reuters through which 100 or so mostly institutional members can buy or sell any listed stock at the current day’s closing price on the New York Stock Exchange. Orders are placed through Reuters’ terminals to the Reuters computer at 5 p.m. EST, and the computer matches them to produce transactions. These transactions are booked as of the next trading day, and they are not reported anywhere.
The cost of trading through the Crossing Network is about a penny a share, which saves a lot of commissions. But its real value for pension funds, insurance companies, bank trust departments and mutual funds is that they can do their business without tipping their hands to the big broker-dealer firms that supposedly act as their agents but actually trade against them in the market. (Two years ago, 80% of traders polled by a division of Institutional Investor magazine agreed that the relationship between the large funds and their brokers had become “inherently adversarial.”)
Few people even on Wall Street have heard of the Crossing Network, and in the first publicity that the service received, a few weeks ago, the estimate was that volume through these machines ran about 2% of the day’s trading. But last spring, Andre Villeneuve, who runs the American end of Reuters, put the Crossing Network’s average share of daily volume at 6% to 7%.
Some days, of course, there will be no volume at all. If the preponderant opinion is that the market will go lower tomorrow, there won’t be many buyers at today’s closing price. Similarly, if the trading community feels strongly that the next day’s price will be higher, few sellers will offer on the Crossing Network.
Oct. 13 was special because a number of mutual funds felt a need to be liquid over the weekend, just in case the 190-point selloff triggered a rush of redemptions. So there had to be offers on the Network at the closing price. The question was, had the offers been taken? Did any number of institutions consider stocks a bargain at the closing prices on Oct. 13--or did they expect to be able to buy for less when the market reopened on Monday?
On this subject, no one would talk. No way. Unlike the guff from analyst X and research director Y that appears in the news columns and on the television shows, information about what had just happened on the Crossing Network was worth money. And even the best sources don’t give reporters information that’s worth money. In entertainment, the rule may be that if you have it you flaunt it; in the markets, if you have it you keep it for your own use.
The Crossing Network is a perfectly legitimate enterprise, and the institutions that use it are not doing anything wrong. They are protecting themselves from the trading activities of the big brokerage houses. And the brokerage houses trade so heavily for their own account because they can’t live on the drastically reduced commissions that institutions are willing to pay for their work as agents. But all this self-defense by the big players leaves the individual investor or trader utterly defenseless, which is why individuals have been fleeing the market.
Sometime next month, if the advance word from Washington holds up, the Securities and Exchange Commission will take action to hide still more trading from public knowledge. Rule 144a, proposed in 1988 and the subject of two public hearings, will come up for adoption. Although it’s a retreat from basic principles--and an invitation to Colombian drug dealers to launder their money through our securities markets--there seems little question that it will pass.
Rule 144a relaxes the old regulations governing “private placements.” Corporations have always been permitted to borrow from and sell stock to small groups of investors without going through the disclosure procedures mandated by the Securities Act of 1933. Such private placements, however, had to be held by the original investors: they could not be sold to the public without going through SEC “registration.”
Under 144a, corporations will be able to sell any amount of paper to institutions with more than $100 million in assets without registering the paper--and the buyers will be permitted to sell the stuff to other such institutions without reporting the terms of sale.
“The key to the analysis of proposed Rule 144a,” the SEC announcement explained, “is that certain institutions can fend for themselves and that, therefore, offers and sales to such institutions do not involve a public offering.” In some versions, the new rule includes stocks as well as bonds, and if the first applications are restricted to bonds, there will obviously be another shoe to drop.
Most privately placed paper will be closely analogous to publicly traded paper from the same corporations. The institutions that trade in the Rule 144a market will have a choice of whether or not to publicize what they are doing. We have been around this barn before in the 1960s, when the “go-go” boys manipulated the market by concealing or publicizing their activities in “letter stock.”
The question is not whether institutions can “fend for themselves” but whether traders and investors who buy and sell the same paper can fend off the institutions. Information doesn’t keep people from doing dumb things, but it gives them a better chance to do smart things. The game is hard enough when the tape tells you what’s happening. Large-scale trading away from the public market means that nobody knows what’s happening except the large-scale traders, and not only the individual investors but also those on whom they rely for guidance are at sea with a doubtful compass. Ask any broker.
And of course the objections to Rule 144a initially lodged by Salomon Bros. remain valid--in this year of the savings and loan scandal, the SEC should remember that the list of institutions with more than $100 million in assets includes 1,000-plus S&Ls.; Some of these are controlled by Colombian drug dons, who can also hire the very best lawyers to set up their very own mutual funds.
The origins of Rule 144a lie in the SEC’s fear that American business will drift away to the less-regulated Euromarkets, where large transactions in bonds and, since February, in stocks are reported only with a time lag, if at all. Oddly enough, the rule will come to the table for adoption at a time when the Europeans are backing away. The Bank of England has set in motion a project to move the clearing of Eurotrades out of Brussels and Luxembourg and back to London. Money laundering was OK when it was businessmen evading taxes or politicians placing the fruits of their thievery, but London has no stomach for these hard-faced fellows with the Uzis.
Justice Louis D. Brandeis observed two generations ago that sunshine is the best disinfectant. That became one of the two guiding principles of our securities laws (the other is, “Keep your hand on your wallet”). In the 1980s, more and more securities transactions have disappeared into the shadows.
Bond trading is on screens, and (as junk bond owners have recently learned) nobody except the insiders knows the prices at which business is really done. Probably as much as 15% of the trading in New York Stock Exchange equities is done in London in an unreported market; another 15% or so involves mysterious computer-based intermarket finagling between Chicago and New York. Now we have the Crossing Network, and just ahead lies the black hole of Rule 144a.
The SEC was chartered to make sure the public had access to the information that the players have. Any action by the SEC that diminishes public information about trading activities gives away the agency’s birthright. But those bowls of porridge that the finance professors cook up at the universities, substituting the artificial sweetener of cost-effectiveness and enhanced liquidity for the honest nutrients of fairness and transparency, are awfully appealing to the poor innocent Esaus who populate the commission today.
