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 Thursday.
"If we identify any activity that violates the securities laws,
we will take appropriate action," 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 for a unified
plan for breaking trades during volatile market periods within two
weeks, Schapiro said during the hearing.
Thursday's 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 analysts 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," 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 were plummeting on
May 6, "only to have stock prices close significantly above their
sale prices."
Schapiro said the exchanges' decision to break trades that
deviate 60% from prices outside of that day's critical 20-minute
time 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," Schapiro said.
Nasdaq OMX (NDAQ) Executive Vice President Eric Noll said later
in the hearing that the decision to break trades was made "somewhat
more arbitrarily than I think any of us are comfortable with."
"Markets that have to resort to breaking trades as a response to
errant conditions are not really markets in my mind," agreed NYSE
Euronext (NYX) Chief Operating Officer Larry Leibowitz.
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 time-out 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 Schapiro why the time-out
should occur for stock prices that go up. Schapiro said five
companies' stocks traded at about $100,000 per share during the
market plunge and recovery.
According to the SEC, they are Apple Inc. (AAPL), Amylin
Pharmaceuticals Inc. (AMLN), American Superconductor Corp. (AMSC),
Sotheby's Holdings Inc. (BID), and Equinix Inc. (EQIX).
People are disadvantaged when they buy a stock at $100,000 as
much as people who have sold a stock at a penny, 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 the volatile half-hour period were
applied "fairly and consistently among investors," Schapiro
said.
The SEC also is investigating market participants to ensure that
they met their "best execution obligations" during a mass selloff,
Schapiro said.
Preliminary findings from regulators about the flash crash
indicate it was caused by a "severe temporary liquidity failure"
and not any economic factor indicating that equities "truly could
drop and recover such a large amount in just a few minutes,"
Schapiro said.
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, hacker or terrorist
activity caused the flash crash.
Schapiro also referenced findings from a joint report on the
crash that the SEC issued earlier this week with the Commodity
Futures Trading Commission.
The Financial Industry Regulatory Authority is working closely
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 dramatic declines during the
30-minute plunge-and-recover period. Those stocks coincided with
securities that were the subject of cancellations and reversals
after the 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, Schapiro
said.
The rule will direct all the exchanges, including the BATS
Exchange and Direct Edge, to come up with a plan to feed
consolidated market data to the SEC, Schapiro said.
The SEC will be taking a closer look at the May 6 activity
around exchange-traded funds, hybrid funds that have shares traded
throughout the day, Schapiro said.
ETFs were affected more than any other securities class by
broken trades, Schapiro said. The SEC is investigating
institutional investors' practice of shorting ETFs to hedge against
broad market exposures, asking whether those shorts contributed to
certain ETFs' dramatic intraday price swings.
The SEC also is looking into exchanges' "self-help" practices.
SEC rules require exchanges to route orders to the exchange that
has the best price. But an exchange can occasionally enter self
help and waive that rule if it perceives unusual activity at
another exchange, allowing it to stop sending orders to that
venue.
Nasdaq OMX and BATS declared self help against NYSE's electronic
trading platform Arca for a short period on the afternoon of May 6.
Schapiro said the SEC is looking into whether there needs to be
"greater consistency in exchange practices with respect to the
self-help mechanism."
CFTC Chairman Gary Gensler and officials from the major
exchanges also were slated to testify. Gensler said in testimony
that an algorithm used when a single trader sold a large number of
stock index futures on May 6 may have caused an unintended impact
because the market lacked liquidity.
Leibowitz said regulators shouldn't "point blame" at
professional traders or certain liquidity providers and should
focus instead on the role of market makers and alternate trading
platforms such as "dark pools."
Terrence Duffy, executive chairman of CME Group Inc. (CME), a
futures market, said lack of consistency in equities markets
exacerbates problems in times of market stress.
-By Fawn Johnson, Dow Jones Newswires; 202-862-9263;
fawn.johnson@dowjones.com
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