The Securities and Exchange Commission will propose new rules covering cancellation of trades in the wake of the May 6 stock market plunge, the agency's chairman told a Senate panel Thursday.
Nearly 21,000 trades were canceled because exchanges deemed them erroneous after the "flash crash," which sent the Dow Jones industrial average down nearly 1,000 points in less than 30 minutes. Many retail investors were affected, and senators pressed at the hearing for remedies.
"The rules have got to have clarity," SEC Chairman Mary Schapiro said. "You've got to provide certainty up front."
Schapiro said the agency is examining whether decisions to cancel trades were made fairly and if market professionals fully met their legal obligations to investors.
The agency will put together new rules governing broken trades in the next few weeks, Schapiro told the Senate Banking subcommittee on securities.
"It's hard for me to understand ... how any trades can be broken arbitrarily by an exchange," said Sen. Jim Bunning, R-Ky. "That is unfair; it undermines market discipline."
The panel also heard from executives from the major exchanges.
Those executives will discuss a plan with the SEC next week that will provide "a clearly defined standard" of when trades should be canceled, said Eric Noll, an executive vice president of Nasdaq OMX Group Inc.
Gary Gensler, chairman of the Commodity Futures Trading Commission, said his agency is considering new rules governing the high-frequency traders that position their powerful computers close to the big exchanges' data centers. The practice, called co-location, can cut the speed traders' times by milliseconds.
High-frequency traders can make money by exploiting stock indexes that don't immediately reflect falling or rising prices of their component stocks, experts say. Their critics say split-second trading without human supervision is a recipe for disaster.
Schapiro said the SEC has received numerous complaints from investors caught in the market plunge and is looking at actions involving all market players. Many of the investors used so-called "stop-loss" market orders to protect themselves in the market freefall. Stop-loss orders set the price at which a stock is automatically sold when it declines to a specified level.
Larry Leibowitz, chief operating officer of New York Stock Exchange Euronext, said the decision to cancel trades "troubled me then and it troubles me now." The exchange canceled about 4,000 trades on May 6.
"Breaking trades is not the right way to make a market function properly," Leibowitz said.
On Tuesday the SEC announced a plan, agreed upon with the exchanges, that would briefly halt trading of some stocks that have big price swings.
The question is whether that will work. The big exchanges say that new curbs on trading known as "circuit breakers" will help prevent runaway market drops. But not everyone is convinced. To some market watchers, the rules are too limited. To others, the rules go too far.
Under the plan, trading of any Standard & 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 new proposed rules would take effect in mid-June under a six-month pilot program.
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