Markets Quiet, Awaiting Move on Impasse

It was supposed to be an easy week.

Between Christmas and New Year’s Day, Wall Street usually goes on hiatus. Trading volume is typically light. And stocks often rise.

But traders, big investors and strategists are paying close attention to their Bloomberg terminals and BlackBerrys this year, as anxiety rises over the budget impasse in Washington.

The Senate plans to resume discussions Thursday over the so-called fiscal cliff, the combination of tax increases and spending cuts that begins on Jan. 1. Without a deal on the table, Wall Street is worried that the economic uncertainty will create turmoil in the final trading days of the year.

On Christmas Eve, Quincy Krosby, chief market strategist at Prudential Annuities, had a laptop alongside the ingredients for apple cake in her rural Connecticut kitchen. “I just go back and forth between watching my apples and watching the markets,” said Ms. Krosby, who is technically on vacation. “Everyone is on call.”

Wall Street is playing the waiting game.

In recent weeks, stocks have moved higher, in anticipation that President Obama and Congress would reach a compromise on the budget. But then the talks collapsed last week. The market saw its sharpest drop in over a month on Friday after House Speaker John A. Boehner failed to summon support from Republicans for a plan to raise taxes on the wealthiest households.

Now, Wall Street is watching to see what comes next.

Some players are creating portfolio contingency plans if a deal doesn’t materialize and stocks plunge. Others are reducing their exposure to stocks that could be particularly vulnerable like financials or energy companies. A faction of opportunists are drawing up buy lists, figuring that bargains will emerge.

“The laptop this week becomes your American Express — you don’t leave home without it,” said Larry Peruzzi, senior equity trader at Cabrera Capital Markets. “This Congress — if it’s taught us nothing else — has taught us you’ve got to be prepared. Because when you think you’ve figured them out, they’re going to do something else and surprise you.”

On Monday, the floor of the New York Stock Exchange was busy for a Christmas Eve, as traders ate free bagels and gathered to sing “Wait Till the Sun Shines, Nellie,” an annual tradition.

Jonathan Corpina, who works on the floor for Meridian Equity Partners, said that on half days like Monday, traders are usually on cruise control, with no big movements. This year, he said the floor was “a little louder today than it normally has been,” given the negotiations in Washington. “There are more people who have given up their end of the year vacations,” he said.

While trading volume remained light, stocks edged lower, building on market declines that started Friday. The Standard & Poor’s 500-stock index ended the day at 1,426.66, off 0.24 percent, or 3.49 points. Even so, the S.& P. 500 is still up over 13 percent for the year. The Dow Jones industrial average fell 51.76 points, or 0.39 percent, to 13,139.08, and the Nasdaq composite index dropped 8.41 points, or 0.28 percent, to 3,012.60.

Interest rates were steady. The Treasury’s benchmark 10-year note fell 1/32, to 98 21/32, as the yield rose to 1.78 percent from 1.77 percent.

If the weakness persists, the markets may not provide their usual holiday boost for investors. Since 1950, equities have risen an average of 1.5 percent in the days after Christmas, what’s referred to by the Stock Trader’s Almanac as the Santa Claus rally. The atmosphere is reminding some of August 2011, when negotiations in Washington over the debt ceiling forced traders to cancel their summer plans. Trading activity picked up as the deadline drew closer and stocks dropped significantly.

Many expect that politicians will come up with a short-term solution to avert the fiscal cliff. But the announcement may not come until the last minute, keeping Wall Street on edge until then.

“What the market is expecting at this point is a stopgap measure,” said Ms. Krosby. “Market activity suggests that investors believe there will be some sort of announcement.”

In the meantime, investors and traders are assessing their portfolios. With taxes on capital gains likely to rise next year, some wealthier individuals are selling winning positions to lock in the current rates.

“Usually people are doing anything they can to avoid locking in gains,” said Oliver Pursche, president of manager at Gary Goldberg Financial Services. “It’s the exact opposite this year.”

Mr. Pursche said he usually takes a vacation between Christmas and New Year’s. This year, he plans to be in the office on Wednesday so that he can be ready to act on any announcements out of Washington.

His firm currently has 15 percent of its assets in cash. If politicians do not reach an agreement and the markets drop, Mr. Pursche plans to use half the money to buy stocks. In Mr. Pursche’s view, concern over the budget impasse has distracted investors from recent indicators that the American economy is actually strengthening. He points, in part, to the falling unemployment rates and the rise in personal income.

But not everyone is so sanguine. David Rovelli at Canaccord Genuity said his firm has hashed out lengthy instructions for clients, detailing what stocks to sell under different outcomes.

On Monday, Santa Claus rang the closing bell at the New York Stock Exchange with the jazz trumpeter Chris Biotti offering a rare moment of holiday cheer for the markets. It was the worst pre-Christmas trading day for stocks since 2006.

Errors Mount at High-Speed Exchanges in New Year

The latest example came Wednesday night when the nation’s third-largest stock exchange operator, BATS Global Markets, alerted its customers that a programming mistake had caused about 435,000 trades to be executed at the wrong price over the last four years, costing traders $420,000.

A day earlier, the trading software used by the National Stock Exchange stopped functioning properly for nearly an hour, forcing other exchanges to divert trades around it. The New York Stock Exchange, the nation’s largest exchange, has had two similar, though shorter-lived, breakdowns since Christmas and two separate problems with its data reporting system. And traders were left in the dark on Jan. 3 after the reporting system for stocks listed on the Nasdaq exchange, the second-biggest exchange, broke down for nearly 15 minutes.

The stream of errors has occurred despite the spotlight on the exchanges since a programming mishap nearly derailed Facebook’s initial public offering on Nasdaq last May and BATS’s fumbling of its own I.P.O. two months earlier. At the end of 2012, a number of exchange executives said they were increasing efforts to reduce the problems. But market data expert Eric Hunsader said that the technology problems have become, if anything, more frequent in recent weeks.

Matt Samelson, the founder of the industry consultancy Woodbine Associates, said, “Now that the world is watching, everyone is trying to be more rigorous. Their increased rigor is not yielding the benefits they hoped.”

Joe Ratterman, the chief executive of BATS, said Thursday that he viewed the firm’s announcement this week as a sign of markets that were functioning well, given his firm’s ability to find a problem that he called an “extreme edge-case scenario.”

“We discovered this problem and reported it — it’s a positive thing,” Mr. Ratterman said. “It’s being covered as if it’s a negative issue, and a continuation of a series of problems.

“Call me an optimist, but I see positive indications of the markets moving forward,” he said.

Regulators and traders have said that malfunctions are inevitable in any complex computer system. But many of these same people say that such problems were less frequent before the nation’s stock exchanges were thrown into a technological arms race in the middle of the last decade as a host of upstart exchanges like BATS challenged incumbents like the New York Stock Exchange.

The nation’s 13 public stock exchanges now compete fiercely to offer the latest, fastest and most sophisticated trading software, in part to appeal to the high-speed trading firms that have come to account for over half of all stock trading. With each tweak comes a new opportunity for a mistake to be inserted into the system.

“The rate of change is getting so rapid that the quality assurance process isn’t as robust as it should be,” said George Simon, a partner at Foley & Lardner who used to work at the Securities and Exchange Commission, which oversees the nation’s stock markets. “This has been something that has been brewing now for five years, and it keeps getting worse.”

Mr. Simon said that in less fragmented and complex markets, technology problems had been less common.

The market malfunctions have been assigned part of the blame for the diminishing amount of trading happening on the nation’s stock exchanges. The total volume of daily trading was down 17.6 percent in 2012 from 2011, according to Rosenblatt Securities.

Mr. Samelson of Woodbine Associates said the problems had long rattled retail investors, but they were becoming increasingly worrying for big institutional investors as well. While he was talking about the BATS mishap on Thursday, he received a text message from one big investor who said, “as if we didn’t have enough bad news.”

The problem reported by BATS was different from many other recent problems because it did not halt trading. Instead, the programming error meant some trades were not executed at the best price, as exchanges are required to do by law.

Only a small category of very complex trades were executed at the wrong prices, all of them coming from investors trying to do a so-called short sale of stocks. The 435,000 erroneous trades were only 0.003 percent of all trades over the last four years, according to Mr. Ratterman.

“This is so hard to identify that no customer ever identified it,” Mr. Ratterman said.

Mr. Ratterman said that 119 member firms lost money. He said he was not yet sure if BATS would compensate its members for their losses. BATS informed the members and the S.E.C. of the problem on Wednesday night, after discovering it on Friday.

The S.E.C. was not previously aware of the problem, but the enforcement division is already reviewing the issue, according to people with knowledge of the review who spoke on the condition of anonymity.

S.E.C. officials have acknowledged that they do not have adequate tools to properly police the high-speed, highly fragmented stock markets. But the agency has started several initiatives to catch up. Last year, the agency purchased software from a high-frequency trading firm that will give regulators a real-time window into the markets.

The agency has also been considering a rule that would force exchanges to submit their technology for regulatory review, something that some exchanges currently do voluntarily. At recent hearings called to examine the automation of the markets, members of the industry have supported other reforms to strengthen the system, like kill switches that would automatically stop errant trading.

Mr. Ratterman said regulators could make small changes to rules that would simplify the market infrastructure and make it less prone to mishaps.

But executives at some other exchanges have said that more sweeping changes are necessary. At a hearing in December, Joe Mecane, an executive at the New York Stock Exchange’s parent company, said that “technology and our market structure have created unnecessary complexity and mistrust of markets.”

Amy Butte, the former chief financial officer at the exchange, said that “you are only going to see more and more of this until someone says, ‘I’m not going to put up with this level of errors.’ ”

Buying the N.Y.S.E., in One Shot

It was January 2000, and Mr. Sprecher had been cold-calling Wall Street for weeks. He was searching desperately for someone to back his small company in Atlanta, a business that was eating up his money and years of his life.

That’s when a black limousine pulled up in front of the bar, Jake’s Dilemma. The limo had been sent by the mighty Goldman Sachs to fetch Mr. Sprecher, and as he sank into the back seat that winter day, he set off on an improbable journey that has since taken him to the pinnacle of American finance.

Today Mr. Sprecher, a man virtually unknown outside of financial circles, is poised to buy the New York Stock Exchange. Not one of the 2,300 or so stocks traded on the New York Stock Exchange (combined value of those shares: about $20.1 trillion). No, Jeff Sprecher is buying the entire New York Stock Exchange.

It sounds preposterous. A businessman from Atlanta blows into New York and walks off with the colonnaded high temple of American capitalism. But if all goes according to plan, his $8.2 billion acquisition, announced a few days before Christmas, will close later this year. And with that, 221 years of Wall Street history will come to an end. No more will New York be the master of the New York Stock Exchange. Instead, from its bland headquarters 750 miles from Wall Street, Mr. Sprecher’s young company, IntercontinentalExchange, will run the largest stock exchange in the nation and the world.

Mr. Sprecher, 57, certainly plays the role of a wily upstart. He may wear power suits and a Patek Philippe watch, but he comes across as unusually casual and self-deprecating for a man in his position. He pokes fun at himself for his shortcomings — “I don’t know how to manage people,” he says — and his love of obscure documentaries.

How the New York Stock Exchange fell into Mr. Sprecher’s hands is, at heart, a story of the disruptive power of innovation. ICE, as IntercontinentalExchange is known, did not even exist 13 years ago. It has no cavernous trading floor, no gilded halls, no sweaty brokers braying for money on the financial markets. What it has is technology.

Like many young companies that are upending the old order in business, ICE has used computer power to do things faster and cheaper, if not always better, than people can. Its rapid ascent reflects a new Wall Street where high-speed computers now dominate trading, sometimes with alarming consequences. New, electronic trading systems have greatly reduced the cost of buying and selling stocks, thus saving mutual funds — and, by extension, ordinary investors — countless millions. But they have also helped usher in a period of hair-raising volatility.

Mr. Sprecher (pronounced SPRECK-er) has probably done more than anyone else to dismantle the trading floors of old and replace human brokers with machines. Along the way, he and ICE have traced an arc through some of the defining business stories of our time — from the rise and fall of Enron, to the transformation of old-school investment banks into vast trading operations, to the Wall Street excesses that not long ago helped derail the entire economy. Now, after a series of bold acquisitions, he is about to become the big boss of the Big Board.

Does it really matter who owns the New York Stock Exchange and its parent company, NYSE Euronext? For most people, stock exchanges are probably a bit like plumbing. Most of us don’t think much about them — until something goes wrong. But lately, some things have gone spectacularly wrong.

One sign of trouble came in 2010, when an errant trade ricocheted through computer networks and touched off one of the most harrowing moments in stock market history. The Dow Jones industrial average plunged 900 points in a matter of minutes, and a new phrase entered the lexicon: flash crash.

Since then, flash crashes in individual stocks have been remarkably common, as the centuries-old system of central exchanges has given way to a field of competing electronic systems.

ICE wasn’t involved in any of these problems. In fact, it has been praised as one of the first exchanges to put limits on lightning-quick, high-frequency trading. This points to Mr. Sprecher’s deftness in piloting his company through periods of regulation, deregulation and now re-regulation.

While many banking executives have clashed with Washington, Mr. Sprecher has sensed the changing winds and tacked accordingly. He also stays close — some say too close — to the powerful Wall Street firms that are his customers.

It is perhaps unsurprising that some of the people who make their living on the Big Board’s floor are a bit nervous about the exchange’s new boss. But Mr. Sprecher says they have nothing to fear. His friends and business associates say he could actually turn out to be the best hope for restoring trust in the stock market. After all, he has beaten the odds before.

“There were a number of times when the odds were long, but he wasn’t deterred from stepping in,” says James Newsome, who was Mr. Sprecher’s regulator at the Commodity Futures Trading Commission before becoming his competitor as chief executive of the New York Mercantile Exchange. “A lot of people, if they don’t think they will win, they won’t participate. Jeff doesn’t operate like that.”

For now, Mr. Sprecher is still spending much of his time at ICE’s headquarters in suburban Atlanta. The contrast with the New York Stock Exchange is striking. Behind its neoclassical face, the Big Board is a sprawling labyrinth of historic oil paintings, gilded leather chairs, stained wood and elegant dining rooms — all set amid crowds of gawking tourists.

Bye-Bye to the Big Board?

If the mergers announced last week go through, NYSE Euronext, the owner of the New York Stock Exchange, will be acquired for $8.2 billion by IntercontinentalExchange, or ICE, an electronic operator of markets for derivatives and commodities, while Knight Capital Group, an electronic trading firm, will be sold for $1.4 billion to Getco, a privately held firm that has been a leader in high-frequency trading.

Both mergers reflect the demise of traditional stock-exchange trading. The equities market has been eclipsed by the global market in derivatives, and human traders have been increasingly replaced by computers programmed to profit from split-second price anomalies.

The mergers also show how regulatory forces are reshaping markets. ICE’s acquisition of NYSE Euronext, which would create one of the world’s largest derivative market operators, is intended to take advantage of new rules that require derivatives to be traded on exchanges and processed through clearinghouses. The merger of Knight and Getco, which would create one of the nation’s most dominant stock traders, would take advantage of securities regulations that have encouraged the development of alternative trading systems.

Just because the mergers seem inevitable, however, does not mean they are desirable.

Criticism has thus far centered on potential antitrust violations. But market share is not the only issue. The question that all regulators must answer is whether the newly created companies can be regulated in a way that also protects the public interest in stable and transparent markets.

For now, the answer is no. Securities and commodities regulators, charged with carrying out the new derivatives rules, simply do not have the resources to enforce those rules, a task that will only become more difficult as derivative market operators compete ferociously.

Larger derivative operators could also pose a threat to taxpayers, because their failure could threaten the broader economy. Regulators have not yet been able to make a convincing case for how taxpayers will be shielded from bailouts of big, interconnected financial firms.

Regulators have made little progress in developing rules to monitor and control high-speed trading. That puts individual investors at risk because they are not in the game of exploiting tiny price variations, and it imperils the economy by promoting trading for trading’s sake.

The mergers should remain on the drawing board unless and until regulators can reassure the public that the newly created companies will operate not only for private gain, but in the public interest as well.

A Change in Carrots, Without a Stick

One big investor, the Louisiana Municipal Police Employees’ Retirement System, wants to change that. Its target is the Simon Property Group of Indianapolis. Last year, that company granted its chief executive, David Simon, a stock award worth $120 million.

The folks down in Baton Rouge aren’t very happy about that. The Louisiana pension fund argues that Mr. Simon’s award should have been put to a shareholder vote, and it has sued Simon Property’s board. The suit raises questions not only about Simon Property but also about the New York Stock Exchange, where Simon’s shares are traded. The Big Board has rules that are supposed to protect shareholders from questionable pay practices.

Now, many companies give their executives what are known as incentive awards, which are supposed to provide some, you know, incentive. This type of pay is usually tied to some measure of the company’s performance. Hit the targets, and you get paid. Miss them, and you don’t.

But at Simon Property, an owner and operator of shopping malls, the only requirement to receive this bounty was that Mr. Simon show up for work.

The legal fracas began in early 2011, when Simon’s board was devising a new employment agreement for Mr. Simon. A particularly generous aspect of the contract was a one-million-share “retention award” under a stock incentive plan created by the company and approved by its shareholders in 1998.

At the time, the grant was worth $120 million. Since then, Simon Property’s share price has risen, so the award is now worth $146 million.

Mr. Simon’s award was to be paid in three installments, beginning on the sixth anniversary of the grant. But, unlike previous grants under the 1998 plan, the terms did not require Simon Property’s performance to meet any benchmarks. The Louisiana fund argues that the switch is so significant that it should have been put to a shareholder vote before the award was made.

Simon Property advised shareholders of the award, but only in July 2011, after the fact. In a securities filing, the company said its board had determined that the deal was in the company’s best interests. The goal was to give Mr. Simon an incentive “to remain with the company for the full eight years of his employment agreement,” the filing said.

THE million-share grant rocketed Mr. Simon to the No. 2 spot among the highest-paid chief executives in the 2011 compensation derby. So it is perhaps not surprising that some Simon Property shareholders became angry. At the company’s annual meeting last May, some 73 percent of shareholders voting on the company’s pay practices opposed them.

But it was too late to stop the award, and, besides, the vote was not binding. The Louisiana fund’s lawsuit was filed a few months later.

Hugh Burns, a spokesman for Simon Property, called the suit meritless. “Mr. Simon has a long track record of delivering truly superior shareholder returns,” Mr. Burns said in a statement. “Over 90 percent of David Simon’s annual target compensation will continue to be at-risk and will be earned only if rigorous performance conditions are met.”

To be sure, companies do not typically ask for shareholder approval on employment contracts. Still, Simon Property’s 1998 incentive plan states that the board can amend it without shareholder approval only if such a vote is not required “by law, regulation or listing requirement.”

This language gave lawyers for the Louisiana retirement system an opening. They argued that granting Mr. Simon one million shares of stock free of any performance measures represented a material change to the 1998 plan. And New York Stock Exchange rules require that shareholders vote on pay plans that undergo material changes.

What kinds of plan changes does the N.Y.S.E. consider material? Its Web site provides guidance. A change that would significantly dilute existing shareholders’ stakes is one example; another is a shift that results in an “expansion of the types of awards available under the plan.”

Because the awards available under Simon Property’s 1998 plan consisted only of those based on performance, lawyers for the Louisiana system contend that eliminating benchmarks from Mr. Simon’s award increased the types of awards available under the plan.

That seems a sensible argument. But not, of course, to the Simon Property Group. And neither, it turns out, to the regulators at the N.Y.S.E.

Errors Mount at High-Speed Exchanges in New Year

The latest example came Wednesday night when the nation’s third-largest stock exchange operator, BATS Global Markets, alerted its customers that a programming mistake had caused about 435,000 trades to be executed at the wrong price over the last four years, costing traders $420,000.

A day earlier, the trading software used by the National Stock Exchange stopped functioning properly for nearly an hour, forcing other exchanges to divert trades around it. The New York Stock Exchange, the nation’s largest exchange, has had two similar, though shorter-lived, breakdowns since Christmas and two separate problems with its data reporting system. And traders were left in the dark on Jan. 3 after the reporting system for stocks listed on the Nasdaq exchange, the second-biggest exchange, broke down for nearly 15 minutes.

The stream of errors has occurred despite the spotlight on the exchanges since a programming mishap nearly derailed Facebook’s initial public offering on Nasdaq last May and BATS’s fumbling of its own I.P.O. two months earlier. At the end of 2012, a number of exchange executives said they were increasing efforts to reduce the problems. But market data expert Eric Hunsader said that the technology problems have become, if anything, more frequent in recent weeks.

Matt Samelson, the founder of the industry consultancy Woodbine Associates, said, “Now that the world is watching, everyone is trying to be more rigorous. Their increased rigor is not yielding the benefits they hoped.”

Joe Ratterman, the chief executive of BATS, said Thursday that he viewed the firm’s announcement this week as a sign of markets that were functioning well, given his firm’s ability to find a problem that he called an “extreme edge-case scenario.”

“We discovered this problem and reported it — it’s a positive thing,” Mr. Ratterman said. “It’s being covered as if it’s a negative issue, and a continuation of a series of problems.

“Call me an optimist, but I see positive indications of the markets moving forward,” he said.

Regulators and traders have said that malfunctions are inevitable in any complex computer system. But many of these same people say that such problems were less frequent before the nation’s stock exchanges were thrown into a technological arms race in the middle of the last decade as a host of upstart exchanges like BATS challenged incumbents like the New York Stock Exchange.

The nation’s 13 public stock exchanges now compete fiercely to offer the latest, fastest and most sophisticated trading software, in part to appeal to the high-speed trading firms that have come to account for over half of all stock trading. With each tweak comes a new opportunity for a mistake to be inserted into the system.

“The rate of change is getting so rapid that the quality assurance process isn’t as robust as it should be,” said George Simon, a partner at Foley & Lardner who used to work at the Securities and Exchange Commission, which oversees the nation’s stock markets. “This has been something that has been brewing now for five years, and it keeps getting worse.”

Mr. Simon said that in less fragmented and complex markets, technology problems had been less common.

The market malfunctions have been assigned part of the blame for the diminishing amount of trading happening on the nation’s stock exchanges. The total volume of daily trading was down 17.6 percent in 2012 from 2011, according to Rosenblatt Securities.

Mr. Samelson of Woodbine Associates said the problems had long rattled retail investors, but they were becoming increasingly worrying for big institutional investors as well. While he was talking about the BATS mishap on Thursday, he received a text message from one big investor who said, “as if we didn’t have enough bad news.”

The problem reported by BATS was different from many other recent problems because it did not halt trading. Instead, the programming error meant some trades were not executed at the best price, as exchanges are required to do by law.

Only a small category of very complex trades were executed at the wrong prices, all of them coming from investors trying to do a so-called short sale of stocks. The 435,000 erroneous trades were only 0.003 percent of all trades over the last four years, according to Mr. Ratterman.

“This is so hard to identify that no customer ever identified it,” Mr. Ratterman said.

Mr. Ratterman said that 119 member firms lost money. He said he was not yet sure if BATS would compensate its members for their losses. BATS informed the members and the S.E.C. of the problem on Wednesday night, after discovering it on Friday.

The S.E.C. was not previously aware of the problem, but the enforcement division is already reviewing the issue, according to people with knowledge of the review who spoke on the condition of anonymity.

S.E.C. officials have acknowledged that they do not have adequate tools to properly police the high-speed, highly fragmented stock markets. But the agency has started several initiatives to catch up. Last year, the agency purchased software from a high-frequency trading firm that will give regulators a real-time window into the markets.

The agency has also been considering a rule that would force exchanges to submit their technology for regulatory review, something that some exchanges currently do voluntarily. At recent hearings called to examine the automation of the markets, members of the industry have supported other reforms to strengthen the system, like kill switches that would automatically stop errant trading.

Mr. Ratterman said regulators could make small changes to rules that would simplify the market infrastructure and make it less prone to mishaps.

But executives at some other exchanges have said that more sweeping changes are necessary. At a hearing in December, Joe Mecane, an executive at the New York Stock Exchange’s parent company, said that “technology and our market structure have created unnecessary complexity and mistrust of markets.”

Amy Butte, the former chief financial officer at the exchange, said that “you are only going to see more and more of this until someone says, ‘I’m not going to put up with this level of errors.’ ”

At the Big Board, Seeking Rejuvenation in Consolidation