Electronic Trading At Center Of SEC ‘Flash Crash’ Inquiry

June 08, 2010

The SEC is focusing on the prevalence of electronic trading and ways to monitor it more carefully, to try to keep the next ‘flash crash’ from ever happening.

The Securities and Exchange Commission is increasingly focused on the ways electronic trading made the “flash crash” on May 6 so much more severe, and is looking at ways to prevent a repeat of the events by curbing trade when it becomes disorderly.

Also getting scrutiny as a possible culprit during the SEC’s ongoing investigation are so-called stub quotes, which refer to minimum and maximum quotes market makers put in place to legally maintain a market. Stub quotes can be a cent or lower, and some securities, particularly ETFs, traded at stub-quote prices on May 6.

The SEC, hearing testimony from a panel of market participants and academics, is moving quickly to put remedies in place, even before the U.S. Congress weighs in. At the center of those recommendations are rules that would shut trading down at specific moments of disorderly trade, as well as the banning of stub quotes.

During the “flash crash,” which came on a day when financial markets were fretting about Greece’s fiscal crisis and civil unrest, U.S. stocks fell almost 10 percent, then whipsawed back upward to end the day 3.2 percent lower in a harrowing episode that unfolded in less than 30 minutes.

Of the more than 300 securities that suffered “broken trades” in the wake of the “flash crash,” about 70 percent were ETFs. The SEC panel noted that most of the canceled ETF trades had stub quotes.

Stub Quotes On Trial

As the New York Stock Exchange slowed trade down, and many so-called high-velocity traders stopped trading as events began to unfold with unprecedented swiftness, too few participants were processing a torrent of sell orders, setting up the circumstances for many trades to be executed at stub-quote prices.

SEC Commissioner Elisse B. Walter asked the panel whether stub quotes “have any place at all” in today’s markets, given the havoc they wreaked on the market on May 6.

“When the best quote is a stub quote, one must question fairness,” said Christopher Nagy, a managing director at discount broker TD Ameritrade.

Limits On High-Speed Trading?

Joseph Ratterman, president and chief executive officer of BATS Exchange, a trading platform that calls itself an alternative to the NYSE and Nasdaq, pointed to high-speed automated trading as another major culprit behind the “flash crash.”

Using powerful computers that can execute trading algorithms in a matter of milliseconds, broker-dealers are able to move vast sums of money in and out of exchanges in the blink of an eye.

Among the recent proposals most likely to affect ETF investors is a rule that would mandate a marketwide, five-minute trading pause for individual stocks and ETFs that decline by 10 percent or more in a five-minute period.

The SEC has also vowed to increase the transparency of off-exchange trading and limit or prohibit unfiltered access to exchanges by the clients—mainly hedge funds—of the large broker-dealers.


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