Wall Street Journal blog Market Watch: SEC Proposes Creating Unified Stock-Halt System
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SEC Proposes Creating Unified Stock-Halt System
Source: Wall Street Journal blog Market Watch
By Ronald D. Orol
The Securities and Exchange Commission and stock-exchange officials on Tuesday proposed the creation of a unified circuit-breaker system for all exchanges to halt or slow down trades of a particular stock if the price moves 10% or more in a five-minute period.
The proposal, which would be market-wide and be set up as a pilot program that runs through Dec. 10, 2010, comes in the wake of the Dow Jones Industrial Average's (DJIA) sudden drop of nearly 1,000 points on May 6 before swiftly recovering to end at a 348-point loss. At one point that afternoon, the Dow dropped 481 points in six minutes and then had recovered 502 points just 10 minutes later.
The SEC noted that during the plunge, at least 30 S&P 500 index stocks fell at least 10% in a five-minute period.
"We continue to believe that the market disruption of May 6 was exacerbated by disparate trading rules and conventions across the exchanges," Securities and Exchange Commission Chairwoman Mary Schapiro said. "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."
Exchanges would need to have their circuit breakers up and operational by mid-June, according to people familiar with the SEC proposal.
The proposal would be subject to a 10-day comment period
"The pause would give the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price and resume trading in a fair and orderly fashion," Schapiro said.
Currently, equity exchanges have inconsistent circuit-breaker policies with respect to individual stocks that experience major price moves. So even if trading in a particular stock is halted for less than a second on one exchange, known as a pause, it isn't halted on other electronic exchanges -- exacerbating a run.
Based on the proposal, exchanges would need to write stock-specific, circuit-breaker listing standards and have them approved by the SEC.
Lawmakers on Capital Hill argued it was an important first step, but said more needs to be done.
"First and foremost, why on May 6 did our markets for 20 minutes stop performing their essential function: discovering the prices of securities based on a balance between buyers and sellers?" asked Sen. Ted KAUFMAN, D-Del. "The answer, I suspect, remains wrapped up with the fact that 70% of the daily trading volume is by black-box computers that, for the most part, do not care about the intrinsic value of the stocks underlying their trades."
"While it is far too soon to determine whether the proposals issued for comment 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-Penn.
Ken Kam, portfolio manager at Marketocracy Capital Management in San Mateo, Calif., said while there should be a unified circuit-breaker system, he remained discouraged by the overall response from regulators to the market meltdown.
"The fact that the SEC, now almost two weeks later, still doesn't have an idea about what caused this is a little alarming," he said. "Would you put your retirement account in anything that would lose 10% in 10 minutes? I think they are losing the confidence of investors. They are fixing the symptom, not the problem."
Others wondered whether a 10-day public comment period -- significantly shorter than the amount of time given to other SEC proposals -- would be enough time for observers to evaluate the measure.
"That may not afford comments an opportunity to provide meaningful comments," said Susan Grafton, partner at Gibson Dunn in Washington. "It will be interesting to see if the SEC's release will address the experience of other jurisdictions that have circuit breakers and whether their trading halts are effective or exacerbate declining markets."
May 6 plunge
The SEC and Commodity Futures Trading Commission released a preliminary report late Tuesday examining the so-called "flash crash" as well as making recommendations.
The agencies said that the plunge may have been due to a possible link between a number of different types of trading at the same time. The plunge could have been due to the combination of a major drop in the prices of stock index products such as index Exchange Trading Funds, the decline of E-Mini S&P 500 futures and "simultaneous and subsequent" waves of selling of stocks, they said.
The report said that trading in E-Mini S&P 500 futures was very high on May 6, and there were many more sell orders than there were buy orders from 2:30 p.m. to 2:45 p.m. on that day.
However, the report also contended that the plunge may also be more directly related to a problem with ETFs, which the commissions claim experienced a "disproportionate" number of broken trades.
The agencies also reported that the "flash crash" may have been due in part to the withdrawal of liquidity by some electronic exchanges, many of which shut down their systems during the quick market decline. At least three major exchanges stopped routing transactions to their exchange's electronic market during the stock market plunge. High-frequency traders, which represent the majority of trading in a given trading day, withdrew from the market as a result.
In addition, the SEC and CFTC pointed to what they saw as a mismatch in trading restrictions in different markets, where some exchanges had circuit breaker stock-specific trading halts and others did not. The agency is responding to this concern, in part, with the circuit breaker rules it proposed Tuesday.
Recalibrating
Schapiro said the agency staff is still working with exchanges about whether to "recalibrate" market-wide circuit breakers that already exist.
An existing unified, market-wide system of circuit breakers would halt exchanges in the event of a 10% drop in the Dow industrials -- a plunge of 1,060 points, based on the current level of the blue-chip benchmark -- before 2 p.m. Eastern time. With a 10% Dow market drop between 2 and 2:30 p.m., the exchanges would halt for half an hour, while any 10% drop after 2:30 p.m. would result in no halt.
Official trading hours on the New York Stock Exchange are from 9:30 a.m. until 4 p.m.
On May 6, the plunge came after 2:30 and didn't result in a Dow drop of 1,050 points or more. As a result, no market-wide halt was triggered.
Agency staffers are discussing whether they would expand an existing circuit-breaker system into one that would have responded on May 6 by halting all exchange trading in the event of a 5% drop in the Dow industrials, according to people familiar with the talks.
The stock-specific proposal comes after the SEC's Schapiro met last week with top Obama administration officials and stock-exchange officials. The group coalesced around the idea of a structural framework "for strengthening circuit breakers and handling erroneous trades."
On Monday, the SEC and the Commodity Futures Trading Commission scheduled for May 24 a meeting of an advisory committee to look into the unusual market events of two and a half weeks earlier.
Key members of the committee include David Ruder, who served as SEC chairman during the 1987 stock market crash, as well as Brooksley Born, who oversaw the CFTC between 1996 and 1999.
Born is known for having issued warnings, which went unheeded, to Congress and the Clinton administration about the need for heightened oversight of over-the-counter derivatives. This lightly regulated market has been widely cited as a key factor behind the 2008 financial crisis and a major contributor to troubles that roiled American International Group Inc. (AIG) , forcing the U.S. government to intervene and take control of majority ownership of the insurance giant via the extension of emergency loans.
Schapiro met last week with Treasury Secretary Timothy Geithner and the heads of eight exchanges including the New York Stock Exchange (NYX) , DirectEdge, International Securities Exchange, Nasdaq OMX Group (NDAQ) , Chicago Board Options Exchange (CME) and others.
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