A Change in The Program

Computer-launched program trading, blamed by many for the severity of the Oct. 19 market meltdown, has become even more controversial in the seven months since the crash. The most widely practiced form of program trading, index arbitrage, has been directly linked to at least two post-crash market plunges, despite new rules designed to limit its effects. All the while, critics have blamed a handful of cash-rich investment firms for turning the stock market into a gambling casino and scaring away small investors.

Last week Wall Street seemed to get the message. In rapid-fire announcements made on the eve of congressional hearings on program trading, six major securities firms -- Salomon Brothers, Morgan Stanley, PaineWebber, Bear Stearns, Kidder Peabody and Dean Witter -- announced that they would halt index arbitrage for their own accounts, at least for the time being. With the exception of Bear Stearns, which will stop all index arbitrage, the firms will continue to execute such trades for customers who request them.

In its pure form, index arbitrage involves the simultaneous purchase of stock index futures contracts and the sale of the stocks that make up the index, or vice versa, to make a profit on the temporary "spread" or price difference between the two. Supporters of this classic kind of arbitrage say it provides a useful and necessary link to equalize prices between the stock markets in New York City and the futures exchanges in Chicago. But recently some Wall Street firms have taken to delaying one or the other leg of the two- part transaction, depending on which way the market is moving. The effect of such "legging," as the practice is called, is to turn a risk-free transaction into a highly speculative one. Critics charge that it has made stock prices more volatile than ever.

Why did the investment houses choose this moment to scale back index arbitrage? Wall Street insiders cite a variety of reasons, but the clincher seems to have been the threat of one of their biggest clients, Maurice . Greenberg, head of the insurance giant American International Group, to stop doing business with companies that continue to profit from program trading. If the firms hoped their announcement would head off further criticism, they were quickly disappointed. At Senate committee hearings the next day, former Treasury Secretary Donald Regan took time off from promoting his new book to urge suspension of all index futures trades. "The public has every reason to believe the present game is rigged," said Regan. "It is." Having spent 35 years at Merrill Lynch, including nine as its chairman, he should know.