Wall Street to install 'circuit breaker' to head off market gyrations

Stock swings of more than 10% in five minutes would trigger trading pause

Regulators plan to enact new rules to curb the type of market volatility behind the May 6 "flash crash" that caused the Dow to plunge almost 1,000 points in a half hour. The goal is to head off market gyrations that can be exacerbated by automated high-speed trading.

The Financial Industry Regulatory Authority (FINRA), which is the enforcement arm of the U.S. Securities and Exchange Commission (SEC), and securities filed the proposed rules on Tuesday. When in place they will pause trading for individual stocks if the price moves 10% or more in a five-minute period.

The rules will likely be rolled out under a six-month pilot program beginning June 14. The SEC is now seeking comment on the planned changes.

"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 in a statement. "As such, I believe it is important that all the exchanges quickly reached consensus on a set of uniform circuit breakers that would be triggered when needed."

Schapiro said the exchange executives and FINRA met at the SEC early last week and reached a consensus on the new rules. About 30 S&P 500 Index stocks fell at least 10% in a five-minute period; some dropped from more than $40 a share to a penny.

Last week, the House Financial Services Committee held a hearing to examine the issues surrounding the U.S. stock market plunge. Although the committee found no single reason for the market drop, it suspected the slide was triggered by an order entry mistake and exacerbated by automated trading systems that process trades in milliseconds.

Speculation has centered around whether the market drop was kicked off by a human error -- a trader entered a sale on an automated trading platform of 16 billion shares of S&P 500 stock. That number should have been 16 million. As the shares flooded the market, buyers stepped back to evaluate what was going on and market liquidity evaporated, O'Dowd said.

The SEC issued a preliminary report on its investigation of the May 6 plunge, and said it still had no evidence of "'fat finger' errors, computer hacking, or terrorist activity, although we cannot completely rule out these possibilities."

The SEC said its ongoing investigation will focus on other possibilities, such a waves of selling in individual securities and the extent to which activity in one market can affect others. It plans to look at what it called "a generalized severe mismatch in liquidity" that was exacerbated by electronic market makers.

Under the proposed rules, which are subject to SEC approval following the public comment period, the pause in trading would give the markets an opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion.

"I believe that circuit breakers for individual securities across the exchanges would help to limit significant volatility," Schapiro said. "They would also increase market transparency, bolster investor protection, and bring uniformity to decisions regarding trading halts in individual securities."

During the congressional hearing last week, NYSE Euronext's chief operating officer, Lawrence Leibowitz, said FINRA had already adopted market-wide circuit breakers after the 1987 market crash, but added that there are "no pre- established mechanisms to address precipitous declines on a stock-by-stock basis, or trading problems that result in market-wide drops of less than 10%."

Leibowitz said the circuit breakers being established now would be "a good step toward restoring faith in the markets," according to Wall Street Journal .

Lucas Mearian covers storage, disaster recovery and business continuity, financial services infrastructure and health care IT for Computerworld . Follow Lucas on Twitter at @lucasmearian or subscribe to Lucas's RSS feed . His e-mail address is lmearian@computerworld.com .

Read more about financial services in Computerworld's Financial Services Knowledge Center.

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