Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : News Links and Chart Links -- Ignore unavailable to you. Want to Upgrade?

To: pallmer who wrote (4380)	12/27/2002 10:52:51 PM
From: pallmer	Read Replies (1) \| Respond to of 29602

-- BARRON'S: The Striking Price -- Dear Mr. Donaldson -- Yes, There Is A Problem In The Options Industry By Kopin Tan Dear Mr. Donaldson: Congratulations on your nomination to become the next chairman of the Securities and Exchange Commission. But let's face it: When you embark next year on your self-described task of restoring investor confidence, the options industry likely won't be a top priority. That is understandable, but unfortunate. For one thing, it overlooks the growing role that options play in the securities business. So far this year, more than 775 million options contracts have traded, affecting the right to buy or sell 77.5 billion shares of stock -- 22% of the year-to-date New York Stock Exchange volume. And despite the market slump, 2002 options volume could surpass 2001's, giving the industry its 11th consecutive record-volume year. But all is not well in the house of puts and calls. Individual investors are staying away. And one practice above all has divided the industry and given the impression that -- as one reader delicately put it in a recent e-mail -- "this business is about as straight as a corkscrew." We are talking, of course, about payments floor traders and exchanges make to certain brokerage firms in return for customer orders steered their way. Since brokers owe customers a duty to route orders to the best market -- and not the best-paying market -- you can see how this might create a conflict of interest. Anywhere else these would be called bribes and kickbacks. But in the options business, they go by the name "payment for order flow" and, increasingly, the rather chic-sounding acronym PFOF. These payments total millions a year (typically 25 cents to $1 per contract of each customer order). But what's really at stake is investor trust, which Wall Street can no longer afford to squander. Just ask Philadelphia Stock Exchange Chairman Sandy Frucher. "I think a key issue in the option industry is payment for order flow and related topics, and that should be at the top of [the new SEC chairman's] agenda," he says. Or ask American Stock Exchange chief Salvatore Sodano. "The area where payment does the most damage is to investor confidence," he says. "It contributes to the perception that the system can be manipulated by money. How can that help investor confidence? Why do we have such a problem in the community right now?" The SEC looked into this issue in 2000. But its report focused on a time right after options began trading at different exchanges, and before consolidation and competition reached today's levels. Even then, the SEC made these findings: Payments present conflicts. They affected where orders are sent, even if "most firms denied that it had any influence on their order-routing decisions." And brokerage firms didn't pass the benefits to customers. Which makes the commission's choice of action -- or, rather, inaction -- these past two years that much more perplexing. Exactly how the SEC plans to contain payment for order flow was never clear from the report; there was some blather about "deference to market forces as they shape market structure" and the need for "ongoing attention." But it essentially left investor protection to existing measures requiring "best execution" of orders -- a standard critics say can be subjective -- and a rule that required brokers to disclose order-routing destinations and any financial inducements they might have received. That way, the SEC said, such payments "will be transparent to investors." Disclosure is a good thing. But as an investor safeguard it's outdated and naive, and about as effective as rubbing two sticks together to start a fire. The average investor doesn't always know where to find these disclosures. Besides, reports on the quality of order executions contain enough mumbo jumbo to drive even professional traders to the Tylenol bottle. How effective is disclosure if investors can't process the information and, when aggrieved, have no clear recourse? What the SEC has done, in effect, is build a confessional, but it hasn't stopped the sin. In fact, by inadvertently easing the consciences of those involved, it has made it easier for them to keep doing it. Ask any trader two years ago why they paid for orders and most griped about their competitors doing it, leaving them no choice but to follow suit. But today, increasingly, part of the answer is "because the SEC has allowed it." Curbing pay-to-play won't be easy. It's just one example of the reciprocal arrangements that exist between brokers and traders, some of which are tougher to police and whose impact on investors are less clear-cut. But enforcement difficulties shouldn't allow the world's largest listed-option market to countenance bribes. And as anyone who's cleaned up after a party knows, you gotta start somewhere. --- KOPIN TAN covers the options markets for the Dow Jones Newswires. --- E-mail: kopin.tan@dowjones.com --- For Barron's subscription information call 1-800-BARRONS ext. 685 or inquire online at barronsmag.com. (END) Dow Jones Newswires 12-27-02 2250ET- - 10 50 PM EST 12-27-02 28-Dec-2002 03:50:00 GMT Source BAR - Barron's