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SEC proposes rules to prevent another 'flash crash'

SEC chief Mary Schapiro says different rules governing when to stop trading led to chaos.
SEC chief Mary Schapiro says different rules governing when to stop trading led to chaos. (Evan Vucci/associated Press)
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Washington Post Staff Writer
Wednesday, May 19, 2010

Twelve days after the stock market took a historic plunge that raised fears of another financial crisis, federal officials are still struggling to understand what went wrong even as they offer proposals for how to avoid another "flash crash."

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Regulators offered several possible explanations Tuesday for what was behind the nearly 1,000 point decline in the Dow Jones industrial average May 6. Without identifying any firms or transactions behind the chaos, regulators said in a report that the losses were probably magnified by outdated and conflicting rules as well as a "complex web of traders and trading strategies" in traditional and more speculative markets.

At the same time, regulators offered a prescription aimed at curbing excessive market volatility. The Securities and Exchange Commission announced that in coming weeks it would require that exchanges pause trading in a stock if it declines more than 10 percent in any five-minute interval.

The report and the new proposal to curb trading reflect a growing recognition by federal officials that they have not adequately regulated the nation's trading hubs at a time when events in some corners of the financial market can spill over rapidly into the rest of the market.

The events of May 6 -- when the price swings of some stocks defied market fundamentals -- dealt a setback to confidence in a financial system already battered by concerns about a worsening debt crisis in Europe.

The SEC's proposal is a response to several lessons of May 6. Several existing triggers, or "circuit breakers," that would normally pause trading were outdated and did not go into effect. Meanwhile, different rules governing when to stop trading led to irregularities across the markets.

"We continue to believe that the market disruption of May 6 was exacerbated by disparate trading rules and conventions across the exchanges," SEC Chairman Mary Schapiro said. "I believe that circuit breakers for individual securities across the exchanges would help to limit significant volatility."

The new rules would apply across all trading venues. The halt in trading would last five minutes.

A full account of what happened may take months to complete, as it did after the spectacular market crash of Oct. 19, 1987, also known as Black Monday.

While today's markets are nearly all electronic, making collection of data easier, the amount of data is far larger. In 1987, about 600 million shares were traded on Black Monday. On May 6, 19.5 billion shares were exchanged in 66 million trades.

A 151-page report on the causes of the May 6 disruption released by the SEC and the Commodity Futures Trading Commission offered preliminary hypotheses for what happened.

The regulators' report sheds no light on which firms and traders helped cause the volatility. But the report underscores how the fate of the stock market today is guided largely by speculators making bets on far-flung trading hubs that can nevertheless have a major influence on the prices of blue-chip stocks.

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