Could it finally be the beginning of the end for Wall Street's most vicious program-trading abuses? Don't relax yet, but there's a little-noticed possibility that one of the worst may finally get its comeuppance this spring.
The target is "self-frontrunning," an obviously unfair and arguably illegal practice in which a major brokerage house manipulates both futures and stock markets within a very short period of time - in order to make a fast and dirty profit for itself while sending prices hurtling scarily in both directions, to the distress of just about everybody else.The people who should have stopped this and other program-trading machinations long ago - the heads of the major exchanges, the managers of huge pension funds, the bosses of reputable brokerage firms - have for the most part continued to bury their heads in the profitable sands, reluctant to cut off such remunerative activities even if they did happen to sour millions of prospective individual investors on the desirability of doing business in Wall Street.
Last July, under pressure from a few bold and noble souls in the industry, the Securities and Exchange Commission finally did approve a tepid intermarket agreement defining and prohibiting index frontrunning, and acknowledging that some of these practices "may be" manipulative. Given the confusion and uncertainty that is deliberately generated by the program-trading crowd, the matter rested there - until now.
With the industry failing so miserably to end such practices on its own, as it should have done years ago, Congress predictably is stepping in. Chairman Edward J. Markey (D-Mass.) of the House telecommunications and finance subcommittee has introduced legislation ordering the SEC to increase its surveillance of such suspicious activities and to move strongly against any violators it uncovers. Wall Street's benefiting powers are fighting hard against these proposed restrictions. The bill is scheduled for a vote in the full committee later this month.
That we have come this far is to a large extent a tribute to one pesky New York stockbroker, Gerald Beirne, who has waged a non-stop campaign against "self-frontrunning," peppering authorities with complaints and ultimately getting the SEC to agree that, while it felt "the widespread existence of such abuses is not as evident or as certain as" Beirne contended, the possibility was now a matter "of serious concern to the commission."
"Self-frontrunning" is simplicity itself - as long as you're an institution with a lot of money and a minimum of conscience. You buy a bunch of futures contracts on, say, the Standard & Poor's 500-stock index. Then you purchase shares in stocks that underlie the index; it doesn't take much strategic buying to send the index, and thus usually the futures, up. You next nail down a lovely profit by unloading those futures contracts you bought earlier, and sell a few extra futures contracts as well, to protect yourself when you take the final step - dumping the stocks you just bought. Those stock sales are fully hedged, since you've sold the futures, and you're fat and happy.
Beirne, who regards the 1989 rules change restricting this practice as "a very obtuse stab at addressing this issue," is convinced that it was basically a cover-up: "To this day, I do not believe that any investigation has been conducted with a thoroughness and sophistication that matches the subtlety and complexity of the abuses it would seek to uncover." He thinks the Markey bill would be a much more meaningful effort on behalf of the victimized small investor.
"I find it particularly ironic," he told me, "that while the peoples of Eastern Europe and Asia are clamoring for a greater stake in their economic destinies, American investors are gradually abandoning the stock market, long held to be the world's most trustworthy vehicle of participatory capitalism . . .
"Rational or not, this mounting desertion of dispirited investors from the dwindling ranks of corporate shareholders is the true measure of the degenerative impact these abuses have on our markets, on our economy and ultimately on our way of life. They must be, they will be, eradicated."
Let's hope that, with or without a push from Congress, Wall Street finally gets with the program - and throws it out.