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New SEC Rules Would Limit Trades in Volatile Market

Source: NY Times

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Posted on 19 May 2010

The Securities and Exchange Commission said Tuesday that it would temporarily institute circuit breakers on all the stocks in the Standard & Poor's 500-stock index after the huge market gyrations on May 6.

The circuit breakers will pause trading in those stocks for five minutes if the price moves by 10 percent or more in a five-minute period. The trial run will begin after a 10-day comment period and will last through Dec. 10, the commission said. The circuit breakers will apply both to rising and falling stock prices.

But in a separate report, the S.E.C. and the Commodity Futures Trading Commission said that they had not been able to pinpoint the cause of the sharp market decline that shook investors and markets two weeks ago.

Generally, the agencies said, the drop was caused by traders stepping back from the market and refusing to buy or sell, in both the stock and futures markets. The government found that there was also a heavy reliance by investors on automated orders to sell at the market price once stock prices had declined by a certain amount. Further, there were different rules on different exchanges about when trading is automatically slowed or stopped.

The agencies said they had found no evidence that the market decline was caused by so-called fat finger trading errors, or by computer hacking or terrorist activity. They added, however, “we cannot completely rule out these possibilities.”

The S.E.C. said it worked with the national securities exchanges and the Financial Industry Regulatory Authority to shape the new rules. The rules require approval by the five-member commission after the 10-day comment period. After the trial, the exchanges will re-evaluate the trading curbs and perhaps expand them to all stocks permanently.

“We continue to believe that the market disruption of May 6 was exacerbated by disparate trading rules and conventions across the exchanges,” Mary L. Schapiro, the S.E.C. chairwoman, said Tuesday. “As such, I believe it is important that all the exchanges quickly reached consensus on a set of uniform circuit breakers that would be triggered when needed.”

But the exchanges also will continue to use different rules about slowing trading in some shares. The New York Stock Exchange said it had independently elected to continue its system of “liquidity replenishment points,” which slow trading in stocks that move a certain amount in a certain time period. Those measures are used across the entire Big Board’s listings, while the proposed individual circuit breakers announced Tuesday apply only to stocks in the S.& P. 500.

The S.E.C. also said it intended to further review the role of the so called self-help mechanism, under which one exchange can refuse to route orders to another if it perceives that orders are not being filled quickly enough. That type of rerouting, around the most liquid markets and to markets where fewer investors were trading, was believed by the agencies to have exacerbated the decline on May 6. For example, as trading slowed on the Big Board because of circuit breakers, orders were routed around the exchange to smaller markets where prices quickly plunged.

During the six-month pilot period, the staffs of the S.E.C. and the C.F.T.C. will also consider other measures discussed during a recent Congressional inquiry into the crash. Those included ways to address the risks of market orders, a potential ban on so-called stub quotes of one or a few cents for a stock that is trading significantly higher than that, and a study of the linkages between futures and equities markets, including the role of exchange-traded funds.

At the May 11 Congressional hearing, Gary Gensler, the chairman of the commodities agency, said the sharp decline in market prices coincided with heavy selling by a single futures trader. That trader accounted for 9 percent of volume in the most active futures contract, a point that was repeated in Tuesday’s report.

The joint commission report is intended to be a road map for the first meeting of the Joint C.F.T.C.-S.E.C. Advisory Committee on Emerging Regulatory Issues, which is scheduled for Monday.

Stock and stock-index futures prices were already declining on May 6 when, about 2:42 p.m. Eastern time, they suddenly plunged by more than 5 percent over the next five minutes.

When prices bottomed at about 2:47 p.m., the Dow Jones industrial average was down nearly 990 points, 9.1 percent below where it had started the day. Almost as quickly as prices dropped, however, they rebounded, with the Dow industrials recovering 543 points in about 90 seconds. The Dow finished the day down 347.80, or 3.2 percent, at 10,520.32.

The review found that almost 200 stocks briefly lost almost all their value during the flash crash, trading in many cases for a single penny. Shares in smaller companies were affected disproportionately. Those companies already were the focus of short-sellers betting that the share prices would decline. More than 70 percent of the penny trades between 2:45 and 2:55 involved short-sellers, the report said.

The investigation identified 11,510 trades in which shares were sold for less than 10 percent of their previous value, involving more than 3.5 million shares. The shares were worth $212.4 million at 2:40 p.m. Over the next 20 minutes, they sold for $557,516.

Prices also increased suddenly for a smaller number of stocks. In a few cases, share prices more than doubled, almost instantly, before falling back.


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