Rules Proposed for Avoiding Another 'Flash Crash' -- Before Cause of Crash Is Known
U.S. stock exchanges would briefly halt trading of some stocks that have big prices swings under the new trading rules proposed Tuesday that are aimed at avoiding market plunges like the one that stunned Wall Street on May 6.
The rules would take effect in mid-June under a six-month pilot program agreed to by major U.S. exchanges and the Securities and Exchange Commission.
Under the plan, trading of any Standard & Poor's 500 stock that rises or falls 10 percent or more within a five-minute span would be halted for five minutes. These rules, known as "circuit breakers," would be applied if the price swing occurs between 9:45 a.m. and 3:35 p.m. Eastern time. That's almost the entire trading day.
On May 6, about 30 stocks listed in the S&P 500 index fell at least 10 percent within five minutes.
Importantly, the new circuit breakers would apply to all U.S. exchanges. Most of the 50 or so U.S. exchanges regulate themselves and design their own tools for slowing or halting trading.
During the recent plunge, the New York Stock Exchange slowed trading according to its rules but the orders that couldn't be executed migrated in a torrent to electronic exchanges, industry officials said.
The SEC and the Commodity Futures Trading Commission, in a report by their staffs, said the agencies' investigation of the epic dive -- in which the Dow Jones industrials lost nearly 1,000 points in less than a half-hour -- is still in a preliminary stage.
"The decline and rebound of prices in major market indexes and individual securities on May 6 was unprecedented in its speed and scope," said the joint report released Tuesday evening. "The whipsawing prices resulted in investors selling at losses during the decline and undermined confidence in the markets."
Only a preliminary picture has started to emerge, the report said. Investigators are focusing on, among other things, a possible link between the steep decline in prices of stock indexes, and "simultaneous and subsequent" waves of selling in individual stocks.
Also being looked at is a "severe mismatch" of liquidity in the market that may have been worsened by the withdrawal of electronic traders and the use of so-called "stop-loss" market orders, the report said. Stop-loss orders set the price at which a stock is automatically sold when it declines to a specified level.
SEC Chairman Mary Schapiro told a gathering of financial analysts Tuesday there are issues "we think can be remediated quickly even before we understand necessarily what the exact cause of the crash was."
The SEC would vote on formally approving the rules sometime after a 10-day comment period, unusually short for the agency's rule-making and indicating the urgency of the issue.
"We continue to believe that the market disruption of May 6 was exacerbated by disparate trading rules and conventions across the exchanges," Schapiro said in a statement. "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."
The markets can use the six-month pilot period, which would end on Dec. 10, to make needed adjustments based on how the new rules work, and the scope of the rules could be expanded to stocks beyond the S&P 500 "as soon as practicable," the SEC said. That could include exchange-traded funds, increasingly popular investments that often track a market index such as the S&P 500 and can be traded throughout the day, unlike mutual funds.
ETFs as a group were affected by the plunge more than any other category of securities, according to the report.
Schapiro has asked the SEC staff to consider during the pilot period ways to address the risks of "stop-loss" and other market orders, and whether so-called "stub quotes" should be curbed or banned. Market makers use stub quotes as placeholders and they are often far above or below actual stock values. But the report said their presence at the top and bottom of order books on May 6 "may have led to a very large number of broken trades."
The SEC already has rules requiring market-wide halts in trading if the Dow falls 10 percent, 20 percent or 30 percent. None of them were triggered on May 6, but it's possible that those rules, also known as circuit breakers, will be re-examined in light of the plunge.
While it is too soon to know whether the proposed new rules "will prove sufficient to protect investors and to shelter our markets from sudden, drastic technology-driven swings in our markets, they are an important first step," said Rep. Paul Kanjorski, D-Pa., chairman of the House Financial Services subcommittee that oversees the SEC.
The new report was submitted to the CFTC-SEC Advisory Committee on Emerging Regulatory Issues, which is holding its first meeting Monday. Its members include Brooksley Born, a former chair of the CFTC; Jack Brennan, a former CEO of fund company Vanguard; and Richard Ketchum, chairman and CEO of the Financial Industry Regulatory Authority, the brokerage industry's self-policing organization.
Jacobs reported from New York. AP Business Writer Mark Jewell in Boston contributed to this report.