SEC approves curbs to avoid repeat of 'flash crash'

SEC Chairman Mary Schapiro announced new rules Thursday.
SEC Chairman Mary Schapiro announced new rules Thursday. (Brendan Smialowski - Bloomberg)
  Enlarge Photo    
By Zachary A. Goldfarb
Washington Post Staff Writer
Friday, June 11, 2010

The nation's financial markets on Friday will start pausing trading in any stock in the Standard and Poor's 500-stock index if it declines more than 10 percent in any five-minute period. The measure is the first significant regulatory response designed to avoid a repeat of the "flash crash" that sent markets gyrating by hundreds of points in a matter of minutes last month.

As regulators continue to dissect what happened May 6, the Securities and Exchange Commission approved curbs Thursday that would attempt to keep trading across all markets orderly if enormous selling pressure occurs. Several existing circuit breakers that would normally pause trading didn't go off May 6. Moreover, trading hubs had differing rules for how to control volatility, leading to additional irregularities throughout the market.

In the flash crash, the Dow Jones industrial average fell nearly 1,000 points in less than an hour, and other major market indicators experienced similar swings. The burst of erratic trading dealt a setback to confidence in the financial system and generated concerns about whether regulations have kept up with the rapidly increasing size and complexity of markets.

The new circuit breakers address these concerns only in part. For now, they affect only the stocks in the S&P 500, and not the more sophisticated financial instruments, such as stock-market futures, that regulators suspect played an important role in fueling last month's volatility.

"The May 6 market disruption illustrated a sudden, but temporary, breakdown in the market's price-setting function when a number of stocks and [exchange-traded funds] were executed at clearly irrational prices," SEC Chairman Mary Schapiro said in a statement Thursday. "By establishing a set of circuit breakers that uniformly pauses trading in a given security across all venues, these new rules will ensure that all markets pause simultaneously and provide time for buyers and sellers to trade at rational prices."

The New York Stock Exchange is expected to introduce the curbs Friday, and Nasdaq will follow Monday, as other exchanges are expected to do. The trading pauses would last five minutes under a pilot program that ends Dec. 10. The SEC may extend the program then and expand it to other stocks and markets later.

The SEC has not concluded what specifically -- firms or transactions -- was behind the flash crash. But regulators have said that a significant contributing factor was probably speculators making bets in far-flung trading hubs that nevertheless had a major influence on the prices of blue-chip stocks.

The SEC is working on a number of other measures to avoid a repeat of the flash crash and is considering curbs on automated, high-speed, computer-driven trading that might have fed the chaos.

It's also looking at banning "stub" quotes that allow market-makers -- firms that agree to buy and sell shares to ensure that investors can make trades -- to technically stay active in the market as is required by some exchanges. These quotes usually are far below or above what the market is asking and are almost never executed. On May 6, trades were executed at extremely low stub prices.

Exchanges have since canceled most of those trades.

© 2010 The Washington Post Company