SEC looks at market makers in May 6th ‘Flash Crash’ stock market plunge

HOT Apple Computers + FREE Shipping“The Securities and Exchange Commission is examining the behavior of market professionals during the puzzling May 6 stock plunge to determine whether they met their legal obligations to investors, SEC Chairman Mary Schapiro said Thursday,” Fawn Johnson reports for The Wall Street Journal. “‘If we identify any activity that violates the securities laws, we will take appropriate action,’ Ms. Schapiro said in written testimony prepared for the Senate Banking Committee’s Subcommittee on Securities, Insurance and Investment.”

MacDailyNews Take: Luckily for anyone who violated securities laws, the SEC seems incapable of identifying its collective ass from its elbow, even when it’s shown to them repeatedly.

Johnson continues, “The SEC also is asking the major trading exchanges for a unified plan for breaking trades during volatile market periods within two weeks, Ms. 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.”

“The SEC has received numerous complaints from investors who had ‘stop-loss’ orders in place to protect against falling markets, she said,” Johnson reports. “Those accounts were liquidated as stocks were plummeting on May 6, ‘only to have stock prices close significantly above their sale prices.'”

Johnson reports, “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.”

“Preliminary findings from regulators about the flash crash indicate that 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,’ she said,” Johnson reports. “Ms. 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 or hacker or terrorist activity caused the flash crash.”

Johnson reports, “NYSE Chief Operating Officer Larry 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.'”

Much more in the full article here.

[Thanks to MacDailyNews Reader “iWill” for the heads up.]

18 Comments

  1. Was it the SEC or FTC that was busted for watching porn during business hrs on taxpayer funded equipment?

    Oh, I guess it doesn’t matter. The behavior in one area of bureaucracy is most likely indicative of it’s pervasiveness in the entire federal government.

  2. What scares me the most is that no one knows why this happened. The brokers have really got this game sussed out. This is all about stock manipulation but the sec aren’t going to admit that.

  3. Johnson reports, “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.”

    Won’t this just give time for more panic sellers to log into their systems and place trades that will execute immediately after the time-out is over?

  4. “complaints from investors who had ‘stop-loss’ orders in place…[whose] accounts were liquidated as stocks were plummeting on May 6, only to have stock prices close significantly above their sale prices.'”

    In other words they chose an investment strategy that entails a risk. When it didn’t work out, they’re whining it wasn’t fair. Auto-pilot orders always carry the threat of this sort of event and other scenarios, which is why I almost never use them. Plenty of others similarly lost that day in panic, even without auto orders. Stay calm, assess the situation, and keep plenty of AAPL in your portfolio. It will always come back, at least for the foreseeable future.

  5. @MacTony – Hey, they got Martha Stewart off TV for a while, even as they were watching porn. Give credit where credit is due. They thought “Madoff” was a strategy, not a name.

    @ Zaphod – Follow the money always applies. One simple change would stop a lot of this nonsense: “All trades will be executed 24 hours after the order is placed.”

  6. One article I read stated that the SEC had traced the crash back to a fat-finger input error by a trader at a smaller midwestern brokerage by the name of Waddell and Reed. According to the story, the trader entered a sell order for a very volatile type of financial futures investment and added an extra zero to the order. That dropped the price in that index of futures, which in turn triggered an avalanche of automated sell orders from other institutional traders. These futures are hedge bets on vast quantities of stocks, and as a result, triggered an avalanche of sell orders of the stocks themselves.

    Nobody is owning up to this of course, but when you consider that major electrical power blackouts have been caused by one fallen tree hitting a power line, which in turn took out a power substation, which led to a chain reaction of power outages down a chain of power stations in a grid, you get the idea. With so many complex financial instruments interconnected to the futures market and computerized trades, it is likely that not enough research has gone into modeling potential catastrophes that could result.

    As sophisticated as we think we are, so exists an equal amount of hubris. Blend that with naked derivatives and short selling and the ability of large brokerage houses to automate large computer trades without any oversight on potential consequences, and you can see how a chain reaction to a small event is entirely possible. It is chaos theory in action.

    My question is, have the markets performed tests of how they would respond to such a possibility? My fear is that the markets and big brokerage houses are so focused on making money that they have not planned for a man-made financial catastrophe and panic that has no basis in fact.

    Such was the case with the knucklehead from Waddell and Reed. A simple stupid human error almost melted down the stock market.

  7. @anti-porkers,

    Never came close to working for Goldman. They just always seem to be hanging around when things fall apart.

    We could also throw Brown Brothers Harriman in for good measure – you know, Prescott Bush’s buddies.

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