WASHINGTON - The Public Securities Association yesterday confirmed that federal antitrust investigators are looking into a rule limiting how government dealers price certain trades of long-term Treasury securities in the inter-dealer market.
Joseph Sims, director of PSA media relations, said the association has been served a subpoena in connection with the Justice Department's investigation.
The probe also involves an undetermined number of primary dealers. including some of the most prominent names on Wall Street. Firms known to have received subpoenas include Bear Stearns & Co., Goldman Sachs & Co., J.P. Morgan Securities Inc., and Paine Webber Inc.
PSA officials and traders in the government bond market said they do not believe any antitrust activity took place. Some openly scoffed at the investigation and called it useless.
The Justice Department's antitrust division has been examining practices by dealers in the government securities since the Salomon Brothers Inc. trading scandal erupted in August 1991.
The issue that came to light yesterday stems from a recommendation by the PSA's Trading Practices Committee in the spring of 1991 setting an increment of 1/64 point in basis trades of Treasury securities with maturities of 10 years or more. Previously, trading increments were allowed in smaller lots of 1/128 point.
According to a report in yesterday's Wall Street Journal, Justice Department officials want to know if the move to adopt wider price spreads in basis trading undermined the ability of smaller firms to participate in the secondary market.
The trading practices committee, which was headed at the time by former Salomon Brothers managing director Thomas F. Murphy, consists of primary dealers and interdealer brokers who review trading practice guidelines. In agreeing to a trading increment of 1/64 point for bonds and 10-year notes, the panel set the same price spread as the one that prevailed for trades in the government cash market.
Murphy was released by Salomon Brothers after his role in the firm's bidding abuses became known. But according to a report in the September 1991 issue of Bond World, a former Thomson publication, he won adoption of the wider pricing spreads with the backing of former PSA general counsel Frances Bermanzohn.
Bermanzohn, now an attorney with Goldman Sachs, did not respond to phone calls.
Basis trades involve the simultaneous buying and selling of a cash security and its futures equivalent. Arbitrage traders often make the trades to try and make money on the difference between a Treasury security and its future contract.
The PSA, in a statement, defended the move as a reasonable measure to standardize trading practices and facilitate this flow of orders. "We believe that once [the Justice Department] has reviewed all of the facts concerning the recommendation, it will conclude that no antitrust enforcement action is warranted," it said.
The association said it "has frequently developed reasonable voluntary trading practice guidelines, including trading increments, for the public debt markets," and that it is up to individual firms to decide whether to implement a recommendation.
Treasury traders said yesterday that the Justice Department's probe had blown the importance of the rule change out of proportion.
The limits on price increments were imposed to increase the liquidity of the Treasury market, and liquidity benefits all participants, they said.
Many traders compared the restriction in the cash market to price changes of 1/64 point or more to the situation at the Chicago Board of Trade, where the bond futures contract trades in increments of 1/32.
The rule limiting price-change increments "was done to facilitate the trading and liquidity of the market," the head of a Treasury trading desk said. "If people keep changing prices in infinitesimal increments, it holds up business. "
The desk head pointed out that a move of 1/128 in the 30-year bond's price resulted in a change of just 0.0005 in the bond's yield. "We're practically trading talcum powder out there." he said.
A salesman for a mid-sized dealership said the rule was just one of a number of restrictions on what kinds of trades dealers could do on brokers' screens, all of which could be viewed as discriminating against smaller dealers.
"Why not say it's discriminatory to limit bids to $1 million or above?" the salesman said. "Why not say any Tom, Dick, or Harry can put a bid up there for $20,000?"
One senior trader at a primary dealer who did not wish to be identified said, "Guys were getting tired of spreads getting narrower and narrower in terms of how they were quoting stuff. It wasn't a big issue at the time. "
But, the trader said, while the change "gives you a wider spread to work with" and "should be more profitable," it "should not prevent you from getting involved in any trade on the brokers' screens."
One interdealer broker who did not wish to be identified commented: "I don't have a problem. I don't think the brokers have a problem either. I'd be surprised if they did. It borders to me on the ridiculous, and I'm usually pretty tough when it comes to antitrust activity in the marketplace."
A spokesman for Cantor Fitzgerald Securities, the largest interdealer broker, declined to comment.
