Regulators search for cause of May 6 crash

The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) have put out several announcements regarding its review of the odd market activity on May 6 but so far neither have made a definitive statement regarding what actually happened.

Yesterday SEC Chairman Mary Schapiro met with the leaders of the New York Stock Exchange, NASDAQ, BATS, Direct Edge, the International Securities Exchange and the Chicago Board Options Exchange as well and the Financial Industry Regulatory Authority to discuss the causes of Thursday's market events. This morning the SEC and CFTC announced the formation of a joint committee that will address emerging regulatory issues. The first item on the agenda is a review of last Thursday’s market events with a focus on market structure issues that may have contributed to the volatility and "disparate trading conventions and rules across various markets. "

One possible factor was the use by NYSE Euronext of mini circuit breakers or Liquidity Replenishment Points (LRPs). These are not the standard circuit breakers that were approved by the SEC following the 1987 Black Monday crash — that would have required a 10% downward move in the Dow Jones. LRPs are mini circuit breakers that the NYSE applies to individuals equities during unusually volatile markets. The NYSE turns off its auto execution function for stocks in LRP mode and all orders for a stock in LRP mode are directed to the Designated Market Maker (DMM) who has an obligation to make a market.

According to a NYSE spokesman, on an average day there will be about 100 instances of LRPs but on May 6 there were more than 1,000.

LRPs are unique to the NYSE and when an equity is in LRP mode other exchanges can trade away from the NYSE regardless of National Best Bid and Offer (NBBO). Orders bypassing the NYSE and going to less liquid venues could explain some of the dramatic prices seen on May 6.

The NYSE spokesman said NYSE did not bust any trades on May 6 and did not experience the wild prices that other venues saw.

In yesterday’s announcement the SEC stated, "As a first step, the parties agreed on a structural framework, to be refined over the next day, for strengthening circuit breakers and handling erroneous trades."

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