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Regulation and Compliance > Federal Regulation > SEC

Flash Crash Update: FINRA, Exchanges Give SEC a ‘Limit Up-Limit Down’ Plan

By Joyce Hanson

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The Financial Industry Regulatory Authority (FINRA) and national securities exchanges on Wednesday filed a proposal with the Securities and Exchange Commission to establish a new “limit up-limit down” mechanism to address extraordinary market volatility in U.S. equity markets, the SEC announced.

Under the proposal, which is subject to SEC approval, trades in listed stocks would have to be executed within a range tied to recent prices for that security, according to an SEC news release. The new limit up-limit down mechanism would replace the existing single stock circuit breakers, which the SEC approved on a pilot basis shortly after the “flash crash” of May 6, 2010.

The exchanges and FINRA have requested that the SEC approve the limit up-limit down plan as a one-year pilot program.

Following a 21-day public comment period, the SEC will vote on whether to approve the proposal. While the circuit-breaker pilot acted as a stopgap measure to slow down electronic trades immediately after the flash crash, SEC Chairman Mary Schapiro (left) is now in favor of instituting a broader and better-developed mechanism.

“Upgrading our trading parameters will help our markets retain the confidence of investors and companies,” Schapiro said in a statement. “We were focused on improving the structure of our markets before weaknesses were exposed on May 6, and we will continue to be focused on market structure going forward.”

On May 6 in the course of just 20 minutes, the Dow Jones industrial average plunged about 700 points then bounced back up again. A November report from the SEC and Commodity Futures Trading Commission found that the giant tumble was triggered by a single, $4.1 billion computer-initiated trade by a Kansas-based Waddell & Reed mutual fund that involved the sale of E-mini futures contracts.

Like Schapiro, the Securities Industry and Financial Markets Association (SIFMA) supports efforts to reduce extreme volatility in the capital markets, but is holding back on giving the FINRA proposal a thumbs-up or thumbs-down.

“We applaud the SEC, FINRA and the exchanges for working diligently on finding solutions that will address volatility in our markets without hampering proper market function and efficiency.  SIFMA and our member firms look forward to reviewing the proposal and providing substantive comments as necessary to further aid the development of these mechanisms that will undoubtedly help restore investor confidence,” said SIFMA Executive Vice President Randy Snook in a statement.

The proposed “limit up-limit down” mechanism would prevent trades in listed equity securities from occurring outside of a specified price band, which would be set at a percentage level above and below the average price of the security over the immediately preceding five-minute period. For stocks currently subject to the circuit breaker pilot, the percentage would be 5%, and for those not subject to the pilot, the percentage would be 10%.

“The percentage bands would be doubled during the opening and closing periods, and broader price bands would apply to stocks priced below $1.00,” according to the SEC release. “To accommodate more fundamental price moves, there would be a five-minute trading pause – similar to the pause triggered by the current circuit breakers – if trading is unable to occur within the price band for more than 15 seconds.”

If approved, all trading centers, including exchanges, ATSs, and broker-dealers executing internally, would have to establish policies and procedures reasonably designed to prevent trades from occurring outside the applicable price bands, to honor any trading pause, and to otherwise comply with the procedures set forth in the plan.

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