Stock exchange leaders to strengthen ‘circuit breakers,’ SEC says
The leaders of six major financial exchanges agreed in principle Monday to strengthen so-called circuit breakers that halt fast-falling electronic trading and help prevent market nose dives, the Securities and Exchange Commission said.
The announcement came after a day of high-level meetings in Washington and ahead of an emergency congressional hearing Tuesday as regulators and lawmakers try to avoid a repeat of last Thursday’s rapid plunge that briefly left the Dow Jones industrial average down nearly 1,000 points.
The SEC and the Commodity Futures Trading Commission still are trying to determine the cause of that day’s market drop.
SEC Chairwoman Mary Schapiro summoned the heads of the New York Stock Exchange, Nasdaq and four other exchanges — including two operations involved in now-prevalent high-frequency automated trading — to discuss market reforms.
“As a first step, the parties agreed on a structural framework, to be refined over the next day, for strengthening circuit breakers and handling erroneous trades,” the SEC said after the meeting.
The group will work to refine the agreement by Tuesday. The SEC hopes to have new rules in place as soon as possible, which could be within weeks, said a person familiar with the talks who requested anonymity because he was not authorized to speak publicly.
The exchange heads, who also included executives from the International Securities Exchange, the Chicago Board Options Exchange, BATS and Direct Edge exchanges, agreed to three broad areas of change, the person said.
•The executives will update the nearly quarter-century-old circuit-breaker system, making the rules uniform across exchanges.
•They will add new circuit breakers for steep price declines in many individual stocks.
•And they will devise clear rules for canceling clearly erroneous trades to replace an ad hoc system in which the exchanges decide among themselves after the fact at what levels particular trades will be voided.
Circuit breakers are designed to stop out-of-control electronic trading that can turn a market downturn into a deep dive. The New York Stock Exchange instituted such circuit breakers after the 1987 market crash to halt trading for 30 minutes to the rest of the day.
The problem then was that human traders could not keep up with volume, said James Angel, an expert on market regulation at Georgetown University. Now, with high-volume, high-speed electronic trading, the circuit-breaker system is outdated and was not capable of stopping Thursday’s wild ride, he said.
Although the point-drop triggers for the Dow are updated routinely, Thursday’s market drop did not trigger the thresholds, which require at least a 10% drop before 11:30 a.m. PDT, or at least a 20% drop after 2 p.m.
Those rules need to be updated to allow brief halts in trading to let people monitoring the electronic systems catch up to the computers, Angel said.
“When a crisis becomes too chaotic, you have the computer call a timeout in trading time and you can short-circuit a lot of these glitches,” he said.
But Larry Harris, a finance professor at USC and former SEC chief economist, said market-wide trading halts were a flawed solution because they could cause fear and panic among investors.
“During the period of the halt, nobody knows how much further the market would have dropped before it was halted, and the fear that it could have dropped more scares people,” he said. “It can be self-fulfilling and creates the same market volatility it seeks to halt.”
Harris said a more effective way was to require investors to place limit orders on stocks instead of market orders.
A limit order is an automatic instruction to seek the best price available, but only within a specific range of prices, to prevent panic selling. Market orders are automatic instructions to seek the best available price, which can help continue to drive down the price of a stock.
After Monday’s SEC meeting, Schapiro and the participants briefed Treasury Secretary Timothy F. Geithner and senior department officials on the progress in analyzing the drop and plans to prevent a recurrence, the Treasury Department said.
Also at that briefing were Commodity Futures Trading Commission Chairman Gary Gensler and officials from CME Group, which runs the Chicago Mercantile Exchange, and from the Financial Industry Regulatory Authority, a self-regulatory body for the securities industry.
Schapiro, Gensler and executives from the New York Stock Exchange, Nasdaq and CME Group are scheduled to testify at a House subcommittee hearing Tuesday on last week’s market drop.
