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Market Features
Questionable Innovation: System Hides Block Trades From the Market
By Christopher H. Schmitt
Staff Reporter
6/23/00 4:36 PM ET
URL: thestreet.com
One recent morning, two stock traders "met" in a closet-sized computer system atop a downtown office building in Philadelphia. There, in the anonymity of cyberspace,
they agreed to trade 10,000 shares of Wal-Mart Stores Inc. (WMT:NYSE).
Nothing unusual about that. Computerized matching systems for big institutional traders have long been a fixture on Wall Street. But there was a big difference. These
two players agreed to the trade without knowing the price. Before the start of trading, they had agreed to settle up at the end of the session at whatever Wal-Mart's
average price for the day turned out to be.
The objective behind this Securities and Exchange Commission-sanctioned pilot by the Philadelphia Stock Exchange is to eliminate the effect on market prices
when big block trades occur.
But that's precisely what raises red flags for critics of the system, which is expected to undergo a major expansion beginning in July. Critics
say that keeping such trades out of the daily market mix hurts everyday investors by altering the true value of stocks and by denying them the
benefits the institutions get.
In essence, the program -- called eVWAP, for electronic volume-weighted average price -- allows big traders to be in the market without ever
really being part of it. That, critics say, is potentially harmful to other investors, who could lose out if they can't benefit from a price change -- up or down -- that a big
block trade might spur.
"I thought the point of an efficient market is the level of interest in a stock determines the appropriate price," says Barbara Roper, director of investor protection for the
Consumer Federation of America. "As soon as you allow people to trade without affecting the price of the stock, it would seem to me you're distorting the
price-setting process."
Promoters, of course, see it differently -- as catering to institutions that are eager to avoid pressuring prices. "When the institutions get too big for the market, they have
to find other things," says Fredric W. Rittereiser, chairman of Ashton Technology Group (ASTN:Nasdaq), developer of the eVWAP system. A blunt-spoken
one-time New York City detective, Rittereiser is a former head of the Instinet electronic trading service.
This new initiative would seem at odds with the SEC's recent push to open up markets and make trading information more widely available. But market forces dictate
the agency be realistic, says Elizabeth King, associate director of the SEC's market regulation division.
She readily admits the Philadelphia system continues a trend toward fragmenting the overall market. But if institutions can't create the most efficient trading systems in
the U.S., she says, they'll simply go elsewhere, such as overseas.
"It's always a tension," she says. "The more orders interact, the more they contribute to [price-setting]. In a perfect world, you could get everybody to display their
trading interest in one place, but that's not going to happen. So why shouldn't we allow for systems to develop to serve those interests?"
The eVWAP system works like this: At least 15 minutes ahead of the 9:30 a.m. market opening, institutions place their orders in 5000-share minimum blocks. By 9:20
a.m., Ashton's system matches buyers and sellers wanting to trade the same stock.
About 15 minutes after the market's 4 p.m. closing, the system calculates the volume-weighted average price for all trades, wherever they took place, and assigns that
price to the orders it matched that morning. Under a volume-weighted average, prices of bigger blocks get more weight in the calculation.
Fund managers and others have long used volume-weighted average price to evaluate traders. Generally, if trades are made at or near the volume-weighted average
price, traders are judged to have made good deals.
Until now, block traders typically have tried to hit the volume-weighted price by "time-slicing" -- that is, chopping their overall orders into small pieces that trade
throughout the day. This can be done manually or through computerized trading programs.
If done fastidiously, this technique can approximate the true volume-weighted average price. But it's more difficult when markets are volatile, as they have been
recently. And, unlike the eVWAP system, the trades are still part of the overall supply and demand equation for the day and thus can affect market price.
According to industry estimates, 13%-15% of all trades today are part of some volume-weighted average pricing strategy. That alone suggests the market for eVWAP
could be big, but some say the figure could reach even 20% or more.
"Every desk you can name wants to take your orders and trade them eVWAP," says Greg Rogers, head trader at Aronson+Partners, a Philadelphia money manager.
After several years of planning and retooling, the Philadelphia exchange won SEC approval for the Ashton system in March 1999. In July the company expects to
accelerate its efforts. Some 70 clients have already signed up -- Rittereiser won't name them, saying the institutions want anonymity. But he says they include floor
brokers, mutual fund managers, bank traders and pension fund managers.
The eVWAP system has approval to trade in 300 of the New York Stock Exchange's most heavily traded issues. It's now trading in just 50, handling about 70,000
shares daily. So for now, and in the immediate future, eVWAP is nowhere near big enough to be a major force.
But within three years, Rittereiser hopes to handle 100 million shares a day and wants to expand into Nasdaq stocks, too.
The chief concern among critics is that the system allows institutions to evade "price discovery" -- which helps establish market prices by exposing buyers' and sellers'
intentions.
The more orders that flow to the eVWAP system, the less they're part of the pool of orders that establish market prices, critics complain. Divert enough orders and
market prices stand to be established on shakier information, they argue.
"Suppose everyone does it -- then there's no market," says Bevis Longstreth, a New York securities attorney and a former SEC commissioner. "Where's the liquidity?"
Taken to the extreme, "we're going to go have 4000 or 5000 shares pricing a million shares," says Greg Bokach, an equity trader for American Century Investment
Management. "People who participate [in the market] should benefit, not be used as a pricing mechanism."
Likewise, many small investors would like to get an eVWAP-style deal, says Mercer Bullard, former assistant chief counsel in the SEC's investment management
division who now heads an advocacy group for mutual-fund investors.
"It takes a lot of the stress out of buying and selling," Bullard says. "People wouldn't have to play the guessing game of selling when the [market] is swooning for the
day, then only to see it come roaring back by the close."
Ashton's Rittereiser acknowledges the importance of price discovery. "Price discovery is the essence of what every market is -- even the stamp market," he says. But,
he says, eVWAP orders are simply a different animal. They represent not traditional trading but instead are actually "derivative," in this case, derived from prices
established during normal trading.
In any case, eVWAP order flow won't hurt overall market pricing, he maintains. "It's a price-taker," he says. "It's in a stream. Those trades are absorbed in the market
as they are moved into the market using this technique."
The chairman of the Philadelphia Stock Exchange, Meyer S. Frucher, likewise rejects the criticisms. "There are a lot of different kinds of investment opportunities and
options that people use to minimize their risk," he says. "This is yet another. There's nothing wrong with that."
What about the concerns of small investors? "The institutions are our constituency," says Rittereiser. "The institutions are the ones who have demanded
volume-weighted average pricing for years."
And besides, he asks, "Can a little guy get into the New York Stock Exchange?"
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