The following is my query to a regular guy I know who is also a member of the NYSE and webmaster for a low key discussion group on market mechanics. This group can be found at: gavinbenton.com
Greg cautioned that this was not a stock he follows or has any opinion on and that I asked him about the action a month after the fact so he does not have a lot of details. Nonetheless, I find it helpful to have a down-to-earth interpretation of what goes on when such dramatic action occurs. Also I find his observation regards 'internet valuation metrics' insightful regards underlying fundamentals vs. market activity.
Greg,
I'm curious how one could characterize the market in SE (Sterling Commerce)
as orderly on February 2, 1999.
I noticed today that the SEC requested from SE an explanation for the
behaviour of their stock.
Should they not have asked their specialist? Would he not have had to
supply a very specific answer - at least regarding the party that
(presumably agreed to a negotiated sale price) opened up this activity by
selling a large block of shares at 25% below the market on 2/5/99? And then
they could ask that party?
By asking the company, it seems like a presumtion of guilt - a leak of
inside info. What sequence of events could have occurred on 2/5/99 that
would fit an 'orderly market' description?
Thanks, Duncan
Response from Greg:
An orderly market is one where brokers with orders in a particular stock are
able to execute those orders efficiently and properly, in accordance with
NYSE rules and practices. A specialist's primary function is to play "air
traffic controller" with brokers, to determine which orders should get
executed when, and which rules apply to a particular situation. As long as
the specialist can do this, and the brokers can execute their orders
properly, the market is considered orderly.
Price change does not necessarily have anything to do with what we consider
an orderly market. For example, consider a stock that is about to be taken
over by another company for a fixed price per share. If you can buy the
stock for less, you'll make a predictable return - this is one type of
arbitrage. There could be dozens of brokers bidding for the stock, all
trying to make that return. If the specialist was unable to determine which
broker is entitled to which trade, and how to apply the rules that govern
that determination, he would fail to maintain a "fair and orderly" market -
and the brokers surrounding him would have no trouble telling him so
(arbitrage brokers tend to be a bit, ummm, earthier, than the standard issue
broker). The price might only be 1/8 different than the last sale, but the
chaos would be considerable.
That said, lets look at Sterling Commerce. I've included a chart covering
the time at issue.
On February 4, the company announced their first quarter earnings after the
close (at 42 1/2) of trading. From the Wall Street Journal: "For the fiscal
first quarter, the company reported a profit of 33 cents a share on revenue
of $140.7 million, compared with 26 cents on $106.2 million in revenue a
year earlier. While the per-share figure was on par with Wall Street
projections, the revenue was a bit slimmer than expected. For example, <Wall
Street Analyst> was expecting revenue of $147 million "
Sterling is an Internet play, so you're dealing with raw emotion rather than
dispassionate analysis. As the Wall Street Journal says, "Sterling has opted
to sacrifice some revenue growth in order to protect its profitability."
That might make sense to you or I (after all, profitability is a good thing,
right?) but it's anathema for an Internet stock play. Investors who had
bought the stock (and I use the term investors guardedly here) for revenue
growth saw their reason for owning the stock evaporate. They wanted to bail
out.
I don't know exactly when the stock opened the next morning, but obviously
it was delayed. In this case, the specialist keeps track of what price the
supply and demand equation becomes balanced, and informs the investment
community through a NYSE standard "Delayed Opening" mechanism. He consults
with NYSE Floor Governors, and disseminates quotes as he and the brokers
involved in the stock hammer out a price. Frequently customers don't tell
their broker or the specialist the complete truth, and as the price changes
the customers change their orders. It works like a giant feedback mechanism,
where each change in the amount to buy or sell changes the price, and each
change in price changes the amount to buy or sell.
Eventually, the specialist decides on a price where everyone is equally
miserable and opens the thing. There really is no science to determining the
proper opening price, but a good opening in a case like this will not change
price too much too soon after it does finally open. It's a "feel" thing that
takes years of experience to learn to do correctly. I can't tell exactly,
but it was about 31. The specialist certainly didn't open it too low,
because it proceeded down another point on HUGE volume. At one point in the
morning, the shares were down 12 5/8 to 29 13/16 on volume of 6.2 million
shares , compared with average volume for the entire day of 724,200.
Because of the NYSE delayed opening procedures, as well as normal specialist
practice, everybody knew within a narrow range where the stock was going to
open well ahead of time. The specialist can't open a stock in a case like
this without input from, and approval by, NYSE officials and brokers
representing the key customers. From a personal perspective, the worst thing
a specialist can do is open a stock at the wrong price. It ruins your day,
all your friends hate you, and the Exchange sends you to see the principal.
The opening and subsequent trading look fine to me. Given the news, the huge
volume, and the initial price change, I'd say the stock traded in a fairly
narrow band after the opening. It closed at 32 1/2, had a high of 33, a low
of 29.75 and volume of 11,126,400 shares. The stock continued in this price
range for several days, with closes at 33, 32 5/16, 34 7/16,33 5/8 for the
next week. Since then, the stock has slid as low as 24 1/8 on 3/1/99. It
closed yesterday at 26 1/4.
As to information regarding trading activity, the SEC and the NYSE have
different roles. The SEC deals with the companies, while the NYSE deals with
the brokers. The specialist only knows which brokerage firm handles an
order. We have no way of knowing, we don't want to know, and aren't allowed
to know, who the ultimate customer is. The brokerage firm that is handling
Fidelity Magellan Fund's sell order in XYZ will go ballistic if that
information gets out, because Magellan's holdings in XYZ are publicly
available. Everyone would be able to figure out their strategy, and other
brokerage firms might try to poach the client. That information is gold, and
it only gets down to the floor broker if it's essential. We never see it.
In a case like this, the NYSE Market Surveillance department already has a
full record of all orders entered through the computer systems, and they
will interview the specialist as a matter of course. The SEC will always ask
the company to comment on unusual trading activity, and the company will
almost always decline to do so. It's just part of the dance between
regulator and regulatee. Thew SEC asked Sterling, and on March 5 the company
declined comment. I didn't research it, but I'm sure the shareholder
lawsuits have already been filed.
We really don't have any inside company information. Our practice is to
discuss with our companies only previously published analysis or news
reports. Besides, if a company isn't telling the analysts the whole story
("it depends on what the meaning of "revenue" is"), they certainly aren't
going to tell us anything different. The SEC asks the company not in order
to have them disclose inside information, but rather to disseminate more
widely information that they may have provided to only a few analysts.
Companies frequently don't understand how or why Wall Street reacts the way
it sometimes does. Not even some analysts do: on February 6, "<Wall Street
BigWig Analyst> said the stock's selloff is an overreaction and he expects
the shares to rebound." It wasn't, and they haven't - at least, not yet.
Orderly means you can do your business fairly and efficiently - that's all.
On this day, SE had a huge price change on even huger volume. That's a sign
of a fair market. If there was huge change on less than average volume,
there would be different questions, and probably different answers. In this
case, the fact that 11 million shares changed hands in a stock that averages
750,000 certainly means the brokers could do their business! I'm sure there
were instances where one broker felt he was overlooked or should have gotten
a better price, but if there is a widespread failure the specialist will
generally try to halt trading rather than risk NYSE sanctions for failing to
perform. We hate to do it, it adds confusion to an already confusing
situation, but it's the only remedy at times.
Long winded I know, but it's an important question. Thanks for asking!
Greg
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