231-922-9460 | Google +

Thursday, June 10, 2010

SEC Approves 'Circuit Breaker'

The Wall Street Journal

Trading exchanges as early as Friday 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.

Members of the Securities and Exchange Commission signed off on the stock market "circuit breaker" Thursday, the agency said.

The New York Stock Exchange said it will begin a phased rollout on Friday. BATS Global Markets and Direct Edge also have said they expect to begin implementation Friday.

The 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 6 "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.

"These new rules will ensure that all markets pause simultaneously and provide time for buyers and sellers to trade at rational prices," said SEC Chairman Mary Schapiro.

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 May 6. 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 Standard & Poor's 500-stock 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 6.

"It is my hope to rapidly expand the program to thousands of additional publicly traded companies," Ms. Schapiro said.

In a letter to the SEC, Rep. Melissa Bean (D., Ill.) 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 window when the circuit breaker would be in effect. TD Ameritrade Inc. 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 6 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 have said they are dissatisfied with the decision to cancel hundreds of trades that occurred during the height of market volatility on May 6. 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.

The SEC is eyeing certain types of buy and sell orders for further regulation. Ms. 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.

Regulators also will be keeping an eye on different exchanges' rules to curb market volatility. NYSE Euronext has a protocol that halts trading in stocks under certain circumstances. Nasdaq OMX Group Inc. last week announced a similar system that it says is designed to complement the stock-by-stock circuit-breaker rule.

Knight Capital Group Inc. said in a letter to the SEC that the NYSE and Nasdaq protocols, combined with SEC rules on market pauses, "could all be triggered during volatile market periods, creating a great deal of confusion and uncertainty."

The NYSE will undergo a phased rollout of the circuit-breaker pilot program, with the circuit breakers for some stocks starting Friday and the remainder being added early next week, according to Raymond Pellecchia Jr., vice president of corporate communications at NYSE Euronext.

By Wednesday, the circuit breakers will be functioning for all affected stocks, he said.

This weekend, the NYSE will provide scripted halt messages during a testing period that will allow member firms to ensure they receive them properly. The exchange hosted a similar testing session last weekend as well. Mr. Pellecchia said firms can participate in the testing remotely, and so it won't necessarily require traders to be on the floor on a weekend.