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The Honolulu Advertiser
Posted on: Tuesday, May 25, 2010

Abandonment may have been cause of plunge


By Marcy Gordon
Associated Press

WASHINGTON — Federal regulators said yesterday they are looking at whether big trading firms abandoned the market during the massive sell-off on May 6 rather than providing cash support required under law.

Staff of the Securities and Exchange Commission said the possible retreat of big "liquidity providers" during the market plunge is an area of focus in the investigation. Major securities firms are required by law to remain in the market by buying and selling stocks; high-speed electronic trading firms are not.

Some firms that act as liquidity providers stopped doing so during the freefall, the SEC officials found.

Those findings were presented at the first meeting of a special advisory committee to the SEC and Commodity Futures Trading Commission. The panel is examining what sent the Dow Jones industrials down nearly 1,000 points in less than 30 minutes.

At the meeting, panel members also pressed staff about the nearly 21,000 trades that were canceled because the exchanges deemed them erroneous after the plunge.

Staff said nearly all the broken trades involved so-called "stub quotes," used by market makers as placeholders and often far above or below actual stock values. The SEC staff is considering whether stub quotes should be curbed or banned.

SEC Chairman Mary Schapiro said last week the agency is examining whether decisions to cancel trades were made fairly and plans to propose new rules for cancellation. Executives from the major U.S. exchanges are expected to meet with the SEC this week to discuss the issue.

The panel also questioned the role of "stop-loss" market orders in the slide. Stop-loss orders set the price at which a stock is automatically sold when it declines to a specified level. Many investors used them to protect themselves in the market freefall.

Last week, the SEC and the exchanges unveiled a plan to adopt "circuit breakers" to pause trading during periods of high volatility. Under the plan, trading of any Standard and Poor's 500 stock that rises or falls 10 percent or more within a five-minute period would be halted for five minutes. The rules would be applied if the price swing occurs between 9:45 a.m. and 3:35 p.m. Eastern time — nearly the entire trading day.

The break is intended to head off a chain reaction of human and computerized selling, one of several possible causes of the May 6 plunge. The drop briefly wiped out $1 trillion in market value as some stocks traded as low as a penny.

Investigators are focusing on a possible link between the steep decline in prices of stock indexes, and "simultaneous and subsequent" waves of selling in individual stocks.

Also being looked at is a "severe mismatch" of liquidity in the market that may have been worsened by the withdrawal of electronic traders, a report by staff of the two agencies says.