Securities Litigation - Monday, July 26, 2010 9:54 - 0 Comments

New Rules Passed To Avoid Another Flash Crash

Trading exchanges will implement rules designed to tame the volatility of individual stocks by temporarily halting trading during dramatic price changes, even as market participants are bracing for stiffer rules. The new rule will be in effect on a pilot basis for six months.

The cross-market trading pause was proposed last month in response to the May 6th “flash crash” that saw the Dow Jones Industrial Average plummet almost 1,000 points before partially recovering. All exchanges will halt trading for five minutes in an individual stock when its price moves 10% or more, up or down, in the previous five minutes. The pause is designed to give traders time to catch their breath and assess whether a stock’s price change stems from a real shift in value or an unrelated market hiccup.

SEC Chairman Mary Schapiro said that the “new rules will ensure that all markets pause simultaneously and provide time for buyers and sellers to trade at rational prices.” The SEC considers the stock-by-stock circuit breaker rule to be the first step of several to curb damage caused by unusual market fluctuations like those seen on May 6th. Regulators haven’t pinpointed a single cause for the incident and are saying it was caused by a confluence of events.

The financial industry generally supports the circuit breaker, but most observers and regulators agree that it alone won’t stop another flash crash from occurring. Right now, the circuit breaker applies only to stocks contained in the S&P 500 index. It doesn’t cover smaller cap stocks or index-based products such as exchange-traded funds, which were some of the stocks most dramatically affected on May 6th. “It is my hope to rapidly expand the program to thousands of additional publicly traded companies,” Schapiro said.

Rep. Melissa Bean (D-IL), in a letter to the SEC, said “I am concerned that by limiting the rules to the issuers in the S&P 500, other issuers will be vulnerable to continued market volatility.” The Issuer Advisory Group suggested that regulators include an “opt-in” provision that would permit non-S&P 500 companies to elect to participate. Other people commenting about the rule are concerned about the market disruptions outside of the 9:45 a.m. to 3:45 p.m. EDT (1345-1945 GMT) window when the circuit breaker would be in effect. TD Ameritrade Holding Corp. (AMTD) said 10% to 15% of its trades on any given day are placed overnight to be executed at market open, leaving those stocks vulnerable for 15 minutes.

As a next step, the SEC is looking to ban “stub quotes,” which are placeholder prices that tend to be far from an actual market price. Normally, those trades won’t get executed. But investigators believe that on May 6th some trades were executed unintentionally at stub-quote prices. The SEC also is working with exchanges to create a unified and predictable policy for breaking erroneous trades. Regulators and exchanges alike have said they are dissatisfied with the decision to cancel hundreds of trades that occurred during the height of market volatility on May 6th. After the flash crash, the exchanges decided to cancel all trades executed at prices that were more than 60% above or below those printed before 2:40 p.m. EDT (1840 GMT).

The SEC is eyeing certain types of buy and sell orders for further regulation. Schapiro has identified two of these types: market orders (orders to buy or sell at market price without regard to fluctuations) and stop-loss orders (orders to sell when a stock falls to a certain price). Investigators of the flash crash believe those types of orders could have accelerated the market drop. If you need more information on this subject contact Scarlette Tuley in our firm at 800-898-2034 or by email at Scarlette.Tuley@beasleyallen.com.

Source: Wall Street Journal