On the morning of Oct. 22, 1987, three days after the historic stock market crash, New York commodity broker B. Thomas Byrne Jr. was glued to his computer screen. He couldn`t believe what he saw.
The opening price in the Chicago Mercantile Exchange`s raucous stock-index futures trading pit had plummeted to 195-an unprecedented free fall of more than 60 points from the closing price the day before. Within minutes, the price rebounded, and within two hours it approached what it had been the previous day.
Such extreme volatility drew stares, even in the unpredictable aftermath of the crash. Tens of millions of dollars had changed hands in the blink of an eye.
”I was wondering if it was real,” Byrne said. ”I had no idea what was going on.”
Byrne, who looked into the matter a few months later for a White House commission investigating the stock collapse, never figured out why the futures market spun out of control that morning. Two years later, the incident remains one of the biggest mysteries of the crash.
A lawsuit filed in federal court in Chicago last week has for the first time publicized the questions that have nagged traders, market watchers and presidential investigators ever since.
The suit by legendary money manager George Soros, whose mutual fund lost millions that morning, makes the startling charge that a small group of greedy traders manipulated the market and made millions at the expense of investors. Soros, who manages the Quantum Fund, charged that his broker, Shearson Lehman Hutton Inc., defrauded the fund out of $60 million that morning. The suit claims the Shearson floor brokers tipped off other traders about a big Soros order to sell index futures at the opening and kept traders from buying until the price had plummeted.
As a result, the order was executed at an artificially depressed price, Soros charged. Meanwhile, traders who bought portions of the order at the cheap price quickly resold at exorbitant profits, the suit alleged.
Shearson said it plans to contest Soros` charges.
Traders buy and sell stock-index futures contracts to bet on stock market price swings or protect their stock holdings. The Merc`s contract is linked to moves in the Standard & Poor`s 500 stock index.
If Soros` lawsuit plays out in federal court, his allegations are likely to raise new questions about the ability of the futures markets to police themselves.
The issue of self-regulation by the exchanges was magnified earlier this year by a sweeping FBI investigation of alleged customer cheating at the Merc and the Chicago Board of Trade.
One reason the Oct. 22, 1987, episode remains a mystery is that the self- regulators and other investigators never talked to some Shearson employees and many of the traders who participated in or witnessed the transactions that caused the dramatic market swing, according to those traders.
The allegations in Soros` lawsuit track claims over the last two years by Barry Haigh, a controversial former Merc trader.
By Haigh`s account, several minutes before stock-index futures trading opened that Thursday, a Shearson broker told traders that he had a huge order to sell. The broker`s action drove the price down unnecessarily, Haigh contended, to the detriment of the Soros fund and the benefit of several Merc traders.
Such secret disclosure of a customer`s plans-a practice known as ”front- running”- would have violated exchange rules and possibly federal criminal laws.
Earlier this year, Haigh and his wife, Carlen, were expelled from the Merc and fined a total of $750,000 for alleged prearranged trading in stock-index futures. Haigh had previously raised eyebrows at the Merc by writing a book critical of exchange practices.
The White House commission, headed by current Treasury Secretary Nicholas Brady, investigated the crash but failed to resolve the questions raised by the market shift. Byrne, the commission staff member who attempted to find out what happened, was an employee of Shearson at the time and said his questions were rebuffed by officials of his own firm.
”People in the firm didn`t want to talk about it,” said Byrne, now a commodity trader at another firm. He said he didn`t pursue the issue further because he was pressed for time and the incident wasn`t central to the commission`s effort to find the causes of the stock crash.
Byrne says he has no doubt that other traders were aware of Soros` order before the market opened. He said the key question is how they found out.
”Did some guy intentionally spill the beans? My honest answer is I simply don`t know,” said Byrne. ”I didn`t try real hard to find out. It was a sensitive thing to me.”
Some traders say the Shearson broker didn`t intentionally tip his hand. In a jittery market, the broker panicked, and others took advantage of his distress, they said.
Shearson investigated the trade two years ago, calling the main floor broker involved, Michael P. Mullins, to New York to explain the episode, a source familiar with the company inquiry said. The brokerage firm incurred a $10 million loss on the trade, because its employees on the floor sold 651 too many contracts for Soros-3,051 instead of 2,400-the source said.
Mullins, in an interview with reporters several months ago, denied tipping off other traders. ”I don`t care what people are saying,” he said.
”This was looked into by Shearson and the Merc, and I was exonerated. That`s the end of it as far as I`m concerned.”
Mullins, who was named in the Soros suit, left Shearson five months later after an unrelated dispute. He did not return phone calls last week.
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The two other Shearson employees named in the suit, who are still working for the firm, also didn`t return calls. They are Douglas A. Young, another floor broker in stock-index futures, and Lawrence J. Israel Jr., who handles institutional customers at Shearson`s order desk on the Merc floor.
Both the federal Commodity Futures Trading Commission and the Merc say they investigated the Oct. 22 incident because of the extreme price swing, but neither has taken any disciplinary action.
The CFTC, in a little-noticed section of its report on the 1987 crash, said its staff didn`t pursue the matter because ”the pattern of trading”
didn`t suggest market manipulation. CFTC officials wouldn`t say whether the agency is currently looking into the incident.
The Merc wouldn`t say whether it specifically investigated charges of front-running, although Haigh said he made the allegations in a taped interview with exchange compliance officials.
Jerrold Salzman, an attorney for the Merc, declined to discuss the Merc`s investigation. But he indicated that much of the Soros order was bought by customers, not by traders who trade for their own accounts, thus disputing the idea that traders conspired to reap illicit profits for themselves.
Merc officials say the episode supports its efforts to improve execution of big orders. Last month, the exchange unveiled a plan to become the first futures market to permit members to match buy and sell orders in stock-index futures outside the trading pit.
The most detailed description of the few minutes after trading began that morning is contained in the CFTC`s report, written two months after the crash, although it doesn`t identify Soros or Shearson.
According to the report, a customer who is clearly Soros placed the sell orders to dispose of 2,400 stock-index futures contracts he had bought the day before.
But that morning (Thursday, Oct. 22), after a two-day rebound, stock prices turned lower. The major market index contract on the Chicago Board of Trade, which opens 15 minutes earlier than the Merc`s S&P 500, began trading at a price 6 percent lower than its closing level on Wednesday.
Two minutes before the opening bell at the Merc, Soros placed a so-called limit order to sell 1,200 S&P 500 contracts at a price of 200. In a limit sell order, the broker must execute the order at the designated price or a higher price. Four minutes after the opening at 8:30 a.m., Soros placed a second, identical order, the CFTC said.
It`s unclear why Soros set a price so far below the previous day`s closing, which was 258.25 index points. News reports at the time speculated that he panicked, presumably because of his large losing position.
”I don`t think it was real smart on George`s part,” said St. Louis trading adviser Tom Basso, echoing the view of many other experts. Soros has declined to comment on the circumstances surrounding the trade.
Haigh claims that once Soros initiated the order, Mullins yelled out before the opening bell that he had ”thousands” of contracts to sell.
Mullins denies telegraphing the number of contracts he was selling before the bell-which would violate exchange rules.
By all accounts, the price dropped dramatically just as trading began, with no buyers coming forward until Mullins cut his offer price to 200, down from Wednesday`s 258.25 closing.
During about six minutes of chaotic trading, described by several traders as a ”feeding frenzy,” Mullins sold all the contracts. Dozens of traders shoved each other aside to get close enough to buy from Mullins, according to traders who were there.
”It was totally nuts,” trader Tim McAuliffe said in an interview several months ago.
Within minutes, a handful of traders had made between $500,000 and $1 million each by immediately reselling futures contracts at sharply increased prices, according to their colleagues in the pit.