SEC’s Schapiro: ‘Flash Crash’ Lessons, One Year Later

‘Volatility Plan’ was enacted in wake of crisis to quickly restore investor confidence

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SEC Chairman Mary Schapiro spoke to attendees at the Investment Company Institute's General Membership Meeting in Washington D.C. Friday, the first anniversary of the so-called stock market "flash crash."

On May 6, 2010, the Dow Jones Industrial Average plunged almost 600 points in 5 minutes, having already lost 4% earlier in the day. The market partially recovered, finishing down 347 points.

As The Associated Press notes, it amounted to “the blink of an eye relative to the decades needed to save for retirement.”

Regulators and stock exchanges are trying to prevent a recurrence. According to the wire service, they've put circuit breakers in place temporarily to briefly halt trading of certain big stocks that veer wildly. The Securities and Exchange Commission is considering longer-term requirements that would bar any trades outside a specified price range. Meanwhile, there hasn't been a comparable stock-market glitch in the past year, and volatility has eased.

sec's mary schapiro“But the significance of May 6 is greater than the investor harm caused by these wild swings in prices–it lies in the significant blow to investor confidence this volatility delivered, as well,” Schapiro (left) said. “Because, while every investor accepts financial risk as a fact of life, they operate under the assumption that America’s markets are structurally sound – that the funds you represent and the investors you advise could confidently entrust their capital to the world’s most sophisticated financial markets.”

When that confidence declines, Schapiro added, the ramifications–in lost wealth and increased cost of capital–can be great.

The SEC’s response, launched in the immediate aftermath of the event, included the following:

all stocks in the Russell 1000 Index, to more than 300 ETFs and to other exchange traded products.

  • The pilot circuit breaker program first applied to stocks listed in the S&P 500 last June has since been extended. It now applies to
     
  • Last September, the Commission approved exchange and FINRA rules designed to bring order and transparency to the process of breaking "clearly erroneous" trades.
  • In November, the Commission approved exchange rules that enhance the quotation standards for market makers and eliminate “stub quotes.” Executions against stub quotes represented a significant proportion of the trades that were executed at extreme prices on May 6th and subsequently broken.
  • Also last November, the Commission adopted a new rule requiring broker-dealers with market access to put in place risk management controls and supervisory procedures on a pre-trade basis – effectively banning naked access.

Schapiro also detailed the SEC’s “Volatility Plan,” enacted in the wake of the crash, to enact changes moving forward:

  • First, the proposed plan would expand the pilot circuit breaker program in two significant respects. It would extend circuit breaker protection to all U.S.-listed equities. And, it would apply circuit breakers during the opening and closing periods of the day, which currently are not covered by the pilot program.
  • Second, it would add a “limit up-limit down” mechanism. This would address weaknesses in the pilot program that permit a single erroneous trade to trigger a full trading pause.
  • Finally, the Volatility Plan proposes cutting in half the price parameters that would trigger a pause, from 10%to 5%. This would greatly reduce the scope for sudden price moves.

“The events of May 6 remind us that despite the enormous benefits and efficiencies of today’s markets, there are risks as well,” Schapiro concluded. “But these risks can be identified and addressed.”

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