SEC Looks at Market Makers in 'Flash Crash'

Discussion in 'Wall St. News' started by ASusilovic, May 20, 2010.

  1. WASHINGTON—The Securities and Exchange Commission is examining the behavior of market professionals during the May 6 stock plunge to determine whether they met their legal obligations to investors, SEC Chairman Mary Schapiro said.

    "If we identify any activity that violates the securities laws, we will take appropriate action," Ms. Schapiro said in written testimony prepared for the Senate Banking Committee's Subcommittee on Securities, Insurance and Investment.

    The SEC also is asking the major trading exchanges to deliver a unified plan for breaking trades during volatile market periods within two weeks, Ms. Schapiro said during the hearing Thursday.

    The congressional hearing is the second in as many weeks on the market "flash crash," when the Dow Jones Industrial Average sank nearly 1,000 points before staging a partial recovery. Policy makers and market participants are clamoring for information about what happened and how to stop a similar event from occurring again.

    "I am deeply concerned about the effects that this volatile market had on investors, especially retail investors," Ms. Schapiro said.

    The SEC has received numerous complaints from investors who had "stop-loss" orders in place to protect against falling markets, she said. Those accounts were liquidated as stocks plummeted May 6, "only to have stock prices close significantly above their sale prices."

    Ms. Schapiro said the exchanges' decision to break trades that deviated 60% from prices outside of the day's wild market swing during a 20-minute period seemed "arbitrary."

    "Going forward, we need a process that is much more transparent, provides certainty in advance about what trades will be broken and which ones won't," she said.

    To keep such a plunge from occurring again, the SEC and the major trading exchanges will implement a cross-market "circuit breaker" in June that will require a five-minute halt in trading for any stock that sees a 10% change in price in the preceding five minutes. Other fixes, such as a marketwide pause and unified trade-cancellation policy, also are in the works.

    Sen. Bob Corker (R., Tenn.) asked Ms. Schapiro why the trading halt should occur for stock prices that go up. She said five stocks, including Apple Inc. and Hewlett-Packard Co., traded at $100,000 during the market plunge and recovery.

    People are disadvantaged when they buy a stock at $100,000 as much as people who have sold a stock at a penny, Ms. Schapiro said. "Fairness really dictates that the circuit breaker works in both directions."

    The SEC is asking whether the exchanges' decisions to break trades that occurred during that volatile period were applied "fairly and consistently among investors," Ms. Schapiro said.

    The SEC also is investigating market participants to ensure they met their "best execution obligations" during the selloff, Ms. Schapiro said.

    Preliminary findings from regulators indicate that it was caused by a "severe temporary liquidity failure" and not any economic factor indicating that stocks "truly could drop and recover such a large amount in just a few minutes," she said.

    Ms. Schapiro's testimony at the hearing echoed her comments given a week earlier before a House panel when she said regulators found no evidence that a "fat finger" typing error or hacker or terrorist activity caused the flash crash.

    Ms. Schapiro also referenced findings from a joint report on the crash that the SEC issued this week with the Commodity Futures Trading Commission.

    The Financial Industry Regulatory Authority, the self-regulatory organization for the securities-trading industry, is working with the SEC and CFTC in its investigation. Finra Chairman Richard Ketchum said in testimony that his staff is focusing on about 300 stocks that experienced the most significant declines during the 30-minute plunge-and-recovery period. Those stocks coincided with securities that were the subject of cancellations and reversals after the May 6 incident, he said.

    To make sure it has easier access to trade data, the SEC is scheduled to vote May 26 on rules requiring national securities exchanges to give regulators data for a consolidated audit trail that collects and aggregates real-time market data, Ms. Schapiro said.

    The rule will direct all the exchanges, including the Bats Exchange Inc. and Direct Edge ECN LLC, to come up with a plan to feed consolidated market data to the SEC, she said.

    The SEC will take a closer look at the May 6 activity around exchange-traded funds, hybrid funds that have shares traded throughout the day, Ms. Schapiro said.

    ETFs were affected more than any other securities class by broken trades, she said. The SEC is investigating institutional investors' practice of shorting ETFs, or betting that they will fall in value, to hedge against broad market exposures, asking whether those shorts contributed to certain ETFs' intraday price swings.