IE 11 is not supported. For an optimal experience visit our site on another browser.

Feds zero in on large traders after flash crash

U.S. regulators are examining the activities of large traders and are reviewing the role of electronic trading platforms as they search for answers to the market's recent swoon.
/ Source: Reuters

U.S. regulators are examining the activities of large traders and are reviewing the role of electronic trading platforms as they search for answers to the market's recent swoon.

Meanwhile, major U.S. exchanges defended high frequency trading activities against lawmakers' charges that the rapid traders have an unfair advantage over the average investor.

Two weeks after the Dow Jones Industrial Average dropped some 700 points within minutes, regulators are grappling with half a dozen theories and have not ruled out anything.

Top futures market regulator Gary Gensler said on Thursday the unexplained May 6 plunge and the rise of algorithmic trading necessitate a review to determine if further protections are needed in these fast-paced, computer-driven markets.

"We will ensure that computer algorithms that interact with each other and meet in a central marketplace -- those of executing brokers, high-frequency traders and market makers, amongst others -- do not threaten fair and orderly markets," Commodity Futures Trading Commission Chairman Gensler said.

Regulators have been analyzing more than 19 billion trades that were executed May 6 and are examining a multitude of factors. Those include the links between declines in prices of stock index products such as E-mini S&P futures contracts and the use of stop loss market orders.

Gensler and Securities and Exchange Commission Chairman Mary Schapiro were testifying on Thursday before a Senate Banking subcommittee hearing to examine the plunge.

Some lawmakers were upset about how trades were canceled after markets closed May 6, including more than 10,000 on the Nasdaq alone. "I am very concerned that trades were canceled on an arbitrary basis," said Senator Jim Bunning, the ranking Republican on the panel. "I am very concerned that it undermines market discipline."

The SEC has given major exchanges two weeks to propose clear rules to cancel trades.

Waddell & Reed
Schapiro reiterated that the events of May 6 were unacceptable and said her staff was investigating whether market professionals violated securities laws during the flash crash.

The CFTC singled out an unnamed trader, saying the firm "sought to hedge its stock portfolio in the futures markets by selling a predetermined amount of futures through an executing broker's automated execution system."

Reuters reported last week that the firm is money manager Waddell & Reed Financial Inc, according to an internal CME Group Inc document that said Waddell sold a large order of E-minis during the critical 20-minute market swoon.

Gensler said the firm entered its sell orders in a way meant to limit the impact on markets, but because of the extreme volume jump, the firm's trading "may have had an unintended market impact."

It took about 21 minutes for the firm to execute its sell order, Gensler said. "In markets with average volume, it would have taken significantly longer -- perhaps hours."

Liquidity under stress
U.S. exchanges told the panel that the high-speed trading firms keep markets liquid and functioning, with one suggesting incentives to encourage their participation at stressful times such as the mysterious plunge.

Regulators should consider "creating better incentives to provide liquidity during periods of market stress," Nasdaq OMX Group Inc Executive Vice President Eric Noll said in prepared remarks.

Terry Duffy, CME Group's executive chairman, said high-frequency trading is an important part of the market and warned against a crackdown, as some have suggested, saying it could move trading to Europe and other foreign jurisdictions.

High-frequency traders use lightening-fast algorithms to make markets and take advantage of tiny imbalances, and are involved in an estimated 60 percent of all U.S. stock trading volume. Some big firms stopped trading during the May 6 plunge.

In an at attempt to prevent a repetition of the market slide, the SEC and major U.S. exchanges have proposed new rules to pause stock trading when markets are in crisis.

The new restrictions known as circuit breakers would apply to all stocks in the Standard & Poor's 500 index and initially would exclude exchange-traded funds (ETFs).

The proposal needs approval from the SEC before the rules go into effect. The SEC plans to roll out the rule in a six-month trial period starting around June.

NYSE Euronext expects that all U.S. stocks will be subjected to the circuit breakers by the end of the year.