This article from the 6/11/99 WSJ is well worth reading.
Heard on the Street
Lofty Preopening Stock Quotes
Studied for 'Screen Painting'
By SUSAN PULLIAM
Staff Reporter of THE WALL STREET JOURNAL
"The tape doesn't lie" was the sucker's folk wisdom; but, in fact, the
tape could be made to lie.
"Once in Golconda:
A True Drama of Wall Street, 1920-1938,"
a 1969 history of the era by John Brooks
In the wild stock market of the Roaring '20s, one of Wall Street's games
was called "painting the tape." Savvy investors secretly formed pools to
buy and sell shares in unison. By creating an illusion of hectic activity on the
ticker tape, they lured in unwitting small investors and then pocketed big
profits by dumping shares when prices were artificially high.
In the electronic age of the 1990s, the name has changed, to "painting the
screen," but the game is pretty much the same.
At 8:15 on a recent morning, Mayer Offman strides into the New York
headquarters of Generic Trading, a small brokerage firm he helps run. He
turns his eyes to his stock-quotation screen, checking prices for Nasdaq
stocks that can be bought and sold on electronic communications
networks, or ECNs, before the Nasdaq Stock Market opens at 9:30 a.m.
The price of Internet-auction company Bid.com stands out. Though it
closed at 16 7/16 the day before, and there hasn't been any major news
on it overnight, Mr. Offman spots a bid price of 25.
Why so high a bid? "It's bogus," Mr. Offman says. It is a case, he believes,
of someone painting the screen with a pretty price to generate excitement
among less-sophisticated investors, who will be led to think Bid.com's
stock is taking off. The amateurs will buy, and the pros will sell.
Mr. Offman is a pro. The head trader at Generic Trading, he already owns
Bid.com shares. And seeing what is going on, he starts selling them, using
an electronic network. Before the Nasdaq market even opens, Mr.
Offman sells nearly 64,000 shares in more than 100 rapid-fire transactions,
getting prices in the low-to-mid-20s and, he says, making a profit of about
$100,000.
Far from being unusual, the action in Bid.com fits a pattern that has
accelerated as the Internet stock craze spread.
"I watch the open," says Bill Burnham, Internet analyst with Credit Suisse
First Boston, "and the initial five minutes [often] have nothing to do with
how the day will turn out ... . There is a lot of gamesmanship going on."
Michael Gottino, a photographer and day trader in Denver, found this out
the hard way. On April 30, he had a $6,000 loss after buying shares of
AboveNet Communications. In what brokerage firms call "the
preopening," it was quoted at three points higher than where it closed the
day before. But when the Nasdaq opened, it quickly dropped. "They
made it look strong," he laments, "but before you know it, you are down
five points."
Though the stock pools of the 1920s would clearly be illegal today,
because investors acted in concert with the express purpose of influencing
prices, painting the screen is a much murkier affair. To seasoned securities
lawyers, a high preopening quote sometimes looks and smells like an
attempt to manipulate a stock's price. But in any given case, this is hard to
know for sure -- and certainly hard to demonstrate.
"Stock manipulation is the granddaddy of charges," says Richard Walker,
chief of enforcement at the Securities and Exchange Commission. "It's not
an easy thing to prove, and the courts have held us to very high standards."
Intent is key. Large buy or sell orders can influence prices, for example,
but that isn't manipulation. What is illegal is deliberately trying to artificially
affect stock prices in order to mislead others. In itself, the posting of an
inexplicably high preopening price isn't proof of manipulation. Market
makers, whose job is to bring buyers and sellers together in the fragmented
Nasdaq market, are permitted to post prices before the opening without
being committed to buy or sell the stock at these prices.
In some cases, they are gauging supply and demand to get a feel for the
price at which they should "open" the stock at 9:30. Sometimes "they are
just trying to find where the point of equilibrium is," says Tom Gira, vice
president of market regulations at the National Association of Securities
Dealers, which oversees Nasdaq.
Still, the frequency of puzzling early-morning price moves has prompted
the SEC to begin conducting inquiries, and the NASD says it is looking
into several "active" cases involving possibly manipulative preopen bidding.
"We're concerned about quoting activity where customers are paying the
high of the day right at the open," Mr. Gira notes.
To some market watchers, all the maneuvering is reminiscent of what went
on in the 1920s and early 1930s, before the Securities Exchange Act of
1934 outlawed acting jointly to tilt share prices. Until then, some prominent
Wall Streeters considered it sport to form pools to influence stocks.
A famous example involved Radio Corp. of America, then a highflier in an
emerging and exciting new business. A 1929 RCA pool included Walter
Chrysler, steel titan Charles Schwab (no relation to the brokerage firm)
and the wife of RCA President David Sarnoff. After accumulating RCA
shares, pool members traded them back and forth, and a stock-exchange
specialist in RCA shares also did his part to artfully move the price up.
The stock's rapid rise caught the eyes of small investors. From 90, the
stock climbed to 109 in a matter of days. Then pool members sold. The
bubble burst, and RCA shares tumbled to 87. Pool members made an
estimated profit of $5 million, or $48 million in today's dollars.
"The players change," says Jack Hewitt, a securities lawyer and former
prosecutor of SEC cases. "But in terms of how the market works, it's the
same as it was ... when the stock pools were around."
Nowadays, the stocks in which the most unusual activity occurs usually are
Internet companies. They tend to have a small number of shares for public
trading, so they can move a lot on light volume, and their volatility helps
disguise what is going on. Moreover, many novice investors buying them
place orders at the market price, rather than set a maximum buying price.
Says the NASD's Mr. Gira: "What we have is a lot of uneducated
investors who are helping to create and complicate the situation by using
market orders."
The unusual trading gyrations spell opportunity for knowledgeable traders
such as Mr. Offman. His firm, Generic Trading, specializes in rapid-fire
"day trading." A core group of 500 traders share their profits and losses
with the firm, while hundreds of independent day traders around the U.S.
execute trades through Generic or a subsidiary, Carlin Financial. As head
trader, Mr. Offman looks for opportunities and offers market advice to the
day traders, who pay a fee for Generic's services.
He and Generic aren't doing anything improper when they try to exploit the
preopening gyrations of stocks such as Bid.com. "I know what an
inefficient price is. A lot of these prices in the morning just don't make any
sense, and I can take advantage of it," he says.
Sometimes, Mr. Offman notes, prices that market makers post on their
Nasdaq terminals are well above the prices for actual trades on ECNs,
like Instinet. When that happens, he adds, there is a strong suspicion the
market maker may be trying to convey a picture of heavy demand with the
hope of causing a stock to open higher than it otherwise might. Then, after
Nasdaq trading begins, the market maker can sell into this strength, or
even dump borrowed shares in a "short sale" -- to be replaced cheaply
after demand tails off, he says.
Although market makers uniformly deny engaging in such schemes, other
professionals believe this occurs. "Some market makers are opening
intentionally at a higher level so that they can buy it back at a cheaper
price," says Matt Johnson, head of Nasdaq trading at Lehman Brothers.
"They are exploiting the customer, and this is a market anomaly that needs
to be corrected."
Indeed, these potential anomalies present opportunities for traders such as
Mr. Offman. Bid.com was just one of his recent winners. On another
morning, it is RealNetworks, a marketer of Internet video products.
RealNetworks closed at 94 27/32 a share the day before. But at 8:41 this
particular morning, Pershing Securities, a unit of Donaldson, Lufkin &
Jenrette that makes a market in RealNetworks, is posting a bid of 99.
Although a stock split took effect the day before, Mr. Offman doesn't
think this is enough news to support a price that high. At 8:46, he sells 400
shares at 98 on Instinet, making a quick profit of $2,500. He thinks of the
99 posted by Pershing as "a meaningless bid. The market maker wants to
sell shares at 98 after trading begins, so he puts the quote at 99."
A Pershing spokeswoman said the trader was attempting to "fine-tune his
bid" that morning. "He was doing price discovery," she says.
At 9:27, just minutes before the opening bell, another RealNetworks
market maker, Sherwood Securities, also posts a bid of 99. Mr. Offman
tries to sell shares to Sherwood at that price, but Sherwood doesn't buy
them.
"I knew they wouldn't honor it. These guys [market makers] never do in
the morning. It's all a big game," Mr. Offman murmurs.
Asked about this, a spokesman for Sherwood says, "Trading at the open
of this stock was in response to customer order flow. There may be
people out there doing bad things. We're not one of them. It was a
perfectly normal thing to do."
By 9:30, when the Nasdaq market opens, both Pershing and Sherwood
have backed away from their offers to buy at 99. RealNetworks opens at
97 3/4 ; though it briefly reaches 100, it trails down for much of the day,
closing at 95 1/8, only 3/8 higher than the day before. The losers: those
who bought at the opening's robust price, thinking the stock was ready to
pop.
The NASD hasn't done much yet to alter the preopen rules. One
proposed change would require market makers to honor all their price
quotes starting 10 minutes before the Nasdaq market opens. But before
that, they would still be free to post unusual bid and ask prices without
having to fulfill orders at those prices.
Why not close the loophole all the way, asks Kenneth Pasternak, chief
executive of the largest market maker in Internet stocks, Knight/Trimark
Group. "If a market is closed, it should be closed," he says. "But if it's
open, you should be held to the price you are quoting."
For his part, Mr. Offman says that as long as the rules stay the way they
are, he will keep getting in early for preopening profit opportunities. |
