Congressman Calls for Collars

On Sept. 30, one day after the Dow Jones Industrial Average plunged 778 points in a single session, Representative Jim Markey advised the Securities and Exchange Commission to force the New York Stock Exchange to reintroduce collars on index-arbitrage trading that had been removed last year.

“I request that the commission consider immediately ordering the NYSE to reinstate its Rule 80A,” Markey, D-Mass., wrote in a letter to SEC chairman Christopher Cox. He said the “current fragility of our nation’s financial markets” warranted this. Rule 80A was imposed in 1988, in response to the Crash of 1987, and rescinded in October 2007.

Markey suggested that the SEC had acted irresponsibly when it allowed the Big Board to do away with Rule 80A, which imposed trading restrictions on index-arb orders whenever the NYSE Composite index rose or declined by more than 2 percent from the previous day’s closing value. The rule required that buy index-arb orders in a rising market take place on a downtick, and sell orders in a declining market take place on an uptick.

Markey was a major proponent of the Market Reform Act of 1990, which gave the SEC authority to battle “extraordinary market volatility” by restraining or controlling trading practices to secure market stability. The legislation was written in the wake of the 1987 market break and the smaller 1989 break. Markey is on the House Energy and Commerce Committee.

The SEC declined to comment on Markey’s letter. An NYSE spokesperson said, “Any such rule would have to apply to all markets, not just the NYSE, to be effective.”

When the exchange did away with Rule 80A, it gave a number of reasons why the rule was no longer effective. First, it told the SEC, index arbitrage was no longer the main strategy contributing to extreme market volatility, as it had been in 1987. Second, the exchange said, restrictions on index-arb trades had become less “meaningful” since the late 1980s, and did not appear to significantly dampen volatility. And third, the rules applied only to stocks in the NYSE Composite index.

Rule 80A also applied only to trading on the NYSE. In 1987, the vast majority of NYSE-listed trading took place on the NYSE. Now, however, only about 30 percent of that trading takes place on the Big Board. Lawrence Leibowitz, head of U.S. execution and global technology at NYSE Euronext, said in October 2007 at the annual Security Traders Association conference that rescinding 80A would enable the Big Board to “be much freer to compete with all the markets on a level playing field in the program-trading arena.”

The NYSE still has marketwide circuit breakers that halt trading when the market moves significantly. Some market participants have criticized the trigger points as being too high. The smallest move that triggers a halt is a 10 percent move in the DJIA from its previous closing value.

Markey didn’t dispute the NYSE’s reasons for rescinding the rule. “If there are other types of trading strategies that may result in increased volatility in our equities markets, the SEC and NYSE would be better advised to update and refresh regulations rather than simply repealing rules restricting one strategy,” he wrote. Referring to the market’s extreme volatility, he added: “Congress gave the SEC the power to address [this] issue 18 years ago-it’s time they [used] it.”

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