A safety switch for equity markets

Does the TSX have "circuit breakers" to stop precipitous falls in the market, similar to those at the New York Stock Exchange?

The TSX has linked its circuit breakers with those of the NYSE. So if the New York market is suspended, trading in Toronto will also stop.

There's a good reason for this, says Michael Prior, vice-president of market surveillance at the Investment Industry Regulatory Organization of Canada (the body that sets these rules). About two-thirds of the volume of trades on the TSX is in stocks interlisted with U.S. exchanges, he said. So it would cause big problems, and not be very effective, if trading on one of the exchanges were to be halted while the other remained open.

The U.S. circuit breakers are a bit complex. The three levels are set at the beginning of each quarter at 10 per cent, 20 per cent and 30 per cent of the average closing price of the Dow Jones industrial index for the preceding month, rounded to the nearest 50.

That means the current levels are 1,100 points, 2,200 points and 3,350 points. These thresholds will likely move downward sharply when they are reset at the beginning of the next quarter in January.

If the Dow drops by one of those values, the markets will shut temporarily, or for the rest of the day, depending on the level and the time of day that it occurs.

The only exception to the link between the NYSE and the TSX is on days when Canadian markets are open and U.S. markets closed. (If July 4 falls on a weekday, for example).

Then, the TSX has its own thresholds (currently 1,250 points, 2,500 points and 3,750 points). These kick in the same way as the U.S. circuit breakers.

IIROC executives can also halt TSX trading on an ad hoc basis if there is a made-in-Canada emergency. This was considered a possibility during the Quebec referendum in 1995, but it has never happened.

The whole circuit-breaker system was set up after the market crash of October, 1987. Initially it was designed to kick in after specific point drops, but the thresholds were changed to the percentage system late in 1997.

The only time the equity circuit breakers have tripped, so far, was on Oct. 27, 1997, when the Dow fell 554 points, or 7.2 per cent. That was enough to stop trading at the levels set at the time.

Is there any way to build my own principal-protected note (PPN) so that I don't have to pay the built-in fees on the ones sold by insurance companies and investment dealers? I also don't want to be subjected to a "protection event" that will kill off any potential for future gains.

It is possible to create a kind of do-it-yourself PPN, which will guarantee your principal and still give you some exposure to market gains (if we ever get any). Here's one suggestion from reader Graeme Tweedie in Halifax.

If you have $100,000 to invest, for example, you could buy a strip bond with a face value of $100,000. It will cost you less than $100,000 - the bond's "present value" - but you will receive the full amount at maturity.

The balance from your $100,000 nest egg could then be used to buy an exchange traded fund linked to the performance of the S&P/TSX composite index. If the value of the ETF rises by the time the strip bond matures, you'll have earned an extra gain related to the market performance.

What are the differences in the regulation of investment banks in Canada compared with the United States? Were U.S. brokers really unregulated?

Independent U.S. investment banks were not completely unregulated, because they were governed by the rules of the U.S. Securities and Exchange Commission. But they had far less regulation than commercial banks, which came under the supervision of the Federal Reserve Board.

In September, however, the last two major investment dealers - Goldman Sachs and Morgan Stanley - became bank holding companies and thus moved under the purview of the Fed. As a result, they will have the same kind of capital requirements as banks, and will not be able to use borrowed money to leverage profits as they have in the past. The SEC will continue to supervise their brokerage activities.

This move puts the U.S. investment banks in a similar position to Canadian dealers. Here, the Office of the Superintendent of Financial Institutions sets the rules for banks' capital ratios and risk management activities on a consolidated basis, so the bank-owned brokerages fall under that umbrella. Canadian brokerage activities are also subject to supervision by provincial securities commissions, or foreign securities regulators if they have activities outside the country.

Are companies allowed to have closed-door meetings with analysts and high net worth investors that others never get to hear about?

A decade ago it was common for companies to hold meetings and conference calls with analysts that no one else was allowed to listen to. This practice has been curtailed, partly because regulations now explicitly say any material information must be disclosed broadly.

Securities legislation makes it crystal clear that it is illegal for companies to reveal material information unless it is "generally disclosed." But regulators have also issued "best practice" guidelines to more specifically deal with conference calls and analyst meetings. They say conference calls and investor conferences should be open to allow anyone to listen, in order to reduce the risk of selective disclosure.

Companies can hold private meetings with analysts, the guidelines say, but these can involve only non-material data, or information that has already been disclosed to the public. For instance, firms can't give new earnings forecasts in these meetings, but they can discuss long-term strategy or the business environment.

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Circuit breakers in place

Trading halt triggers on the New York Stock Exchange.

Level 1 (10 per cent)*

- 1,100 points

Before 2 p.m., a one-hour halt.

Between 2 p.m. and 2:30 p.m., a half-hour halt

At 2:30 p.m. or later, no halt unless Level 2 reached

Level 2 (20 per cent)

- 2,200 points

Before 1 p.m., a two-hour halt

Between 1 p.m. and 2 p.m., a one-hour halt

At 2 p.m. or later, no trading for the rest of the day

Level 3 (30 per cent)

- 3,350 points

At any time, trading is stopped for the rest of the day

* based on average level of DJIA for month previous to quarter's start, rounded to nearest 50

Source: IIROC

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WALL STREET STILL HAS BILLIONS FOR BONUSES

Even as the credit crisis triggers widespread job cuts, three Wall Street firms have set aside an estimated $20-billion (U.S.) to pay bonuses so far this year.

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Last year, Morgan Stanley's John Mack, above, bypassed his year-end bonus, while Merrill Lynch CEO John Thain, above right, took home a $15-million (U.S.) cash bonus just for taking the job last Dec. 1. Goldman Sachs's Lloyd Blankfein, earned $70.3-million last year, making him Wall Street's most highly compensated chief executive officer.

*Based on estimates that 60% of compensation expense is paid out in year-end bonuses.

**Excludes job cuts and additions since third-quarter figures were reported.

BLOOMBERG/THE GLOBE AND MAIL

SOURCE: THE COMPANIES