SEC Approves, Extends New Circuit Breakers

The new rules, which had been submitted by the national securities exchanges and FINRA in the wake of the so-called May 6 “flash crash”, extend to all stocks in the Russell 1000 Index and certain exchange-traded funds (ETFs). The SEC also approved new exchange and FINRA rules that clarify the process for breaking erroneous trades.  Nearly 21,000 trades were broken during that market plunge, the largest chunk of which was in exchange-traded funds, according to an SEC preliminary report released earlier this year.  On May 6 the Dow Jones Industrial Average dropped nearly 1,000 points before recovering to a 348-point loss.   

The circuit breaker pilot program was approved in June, and currently applies to stocks listed in the S&P 500 Index. In announcing the change, the SEC notes that trading in a security included in the program is paused for a five-minute period if the security experiences a 10% price change over the preceding five minutes. The SEC said this pause “gives the markets an opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion”. That circuit breaker program is still in effect on a pilot basis through December 10, 2010, and the new rules will also be in effect on a pilot basis through that date.

“These circuit breakers and this more objective guidance on breaking erroneous trades will help our markets retain the confidence of investors and companies,” said SEC Chairman Mary L. Schapiro. “We have worked quickly with the exchanges to take these steps, and we will continue to be very focused on addressing weaknesses exposed on May 6.”

The SEC noted that on May 6 the markets only broke trades that were more than 60% away from the reference price “in a process that was not transparent to market participants”.  The SEC went on to note that “by establishing clear and transparent standards for breaking erroneous trades, the new rules should help provide certainty in advance as to which trades will be broken, and allow market participants to better manage their risks”.

The SEC said that it anticipates that the exchanges and FINRA will begin implementing the expanded circuit breaker program early next week, and that the markets will “continue to use the pilot period to make appropriate adjustments to the parameters or operation of the circuit breakers as warranted based on their experience”.

The list of exchange-traded products included in the pilot is available on the SEC’s website.

http://www.sec.gov/rules/sro/nysearca/2010/34-62413-ex3.pdf

The rules outlined were:

• For stocks that are subject to the circuit breaker program, trades will be broken at specified levels depending on the stock price:
• For stocks priced $25 or less, trades will be broken if the trades are at least 10 percent away from the circuit breaker trigger price.
• For stocks priced more than $25 to $50, trades will be broken if they are 5 percent away from the circuit breaker trigger price.
• For stocks priced more than $50, the trades will be broken if they are 3 percent away from the circuit breaker trigger price.

Where circuit breakers are not applicable, the exchanges and FINRA will break trades at specified levels for events involving multiple stocks depending on how many stocks are involved:

• For events involving between five and 20 stocks, trades will be broken that are at least 10 percent away from the "reference price," typically the last sale before pricing was disrupted.
• For events involving more than 20 stocks, trades will be broken that are at least 30 percent away from the reference price.

At Chairman Schapiro's request, the SEC staff is also:

• Considering whether market makers should be subject to more meaningful obligations to promote fair and orderly markets.
• Working with the exchanges to prohibit the use by market makers of "stub" quotes that are not intended to indicate actual trading interest.
• Studying the impact of multiple trading protocols at the exchanges, including the use of trading pauses and self-help rules. 

According to the announcement, the SEC staff also intends to work with the markets and CFTC staff to consider recalibrating market-wide circuit breakers currently on the books — none of which was triggered on May 6. These circuit breakers apply across all equity trading venues and the futures markets.