Washington, D.C., April 5, 2011 – The Securities and Exchange Commission today announced that national securities exchanges and the Financial Industry Regulatory Authority (FINRA) today filed a proposal to establish a new “limit up-limit down” mechanism to address extraordinary market volatility in U.S. equity markets.
Under the proposal, trades in listed stocks would have to be executed within a range tied to recent prices for that security.
If approved by the Commission, the new limit up-limit down mechanism would replace the existing single stock circuit breakers, which were approved on a pilot basis shortly after the market events of May 6, 2010.
The SEC will seek comment on the proposed plan, which is subject to Commission approval following a 21-day public comment period.
Limit Up-Limit Down Requirements
The proposed “Limit Up-Limit Down” mechanism would prevent trades in listed equity securities from occurring outside of a specified price band, which would be set at a percentage level above and below the average price of the security over the immediately preceding five-minute period. For stocks currently subject to the circuit breaker pilot, the percentage would be 5 percent, and for those not subject to the pilot, the percentage would be 10 percent.
The percentage bands would be doubled during the opening and closing periods, and broader price bands would apply to stocks priced below $1.00. To accommodate more fundamental price moves, there would be a five-minute trading pause – similar to the pause triggered by the current circuit breakers – if trading is unable to occur within the price band for more than 15 seconds.
If approved, all trading centers, including exchanges, ATSs, and broker-dealers executing internally, would have to establish policies and procedures reasonably designed to prevent trades from occurring outside the applicable price bands, to honor any trading pause, and to otherwise comply with the procedures set forth in the plan. The exchanges and FINRA have requested that the SEC approve the plan as a one-year pilot program.
“Upgrading our trading parameters will help our markets retain the confidence of investors and companies,” said SEC Chairman Mary L. Schapiro. “We were focused on improving the structure of our markets before weaknesses were exposed on May 6, and we will continue to be focused on market structure going forward.”
Existing Circuit Breaker Approach
Under the existing circuit breaker pilot, trading in a stock pauses across the U.S. equity markets for a five-minute period if the stock experiences a 10 percent change in price over the preceding five minutes. The pause gives the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion.
The circuit breaker pilot was initially approved by the SEC on June 16, 2010, and is currently set to expire on Aug. 11, 2011 (or earlier if the limit up-limit down mechanism is implemented before then). The circuit breakers apply to securities in the S&P 500 Index and Russell 1000 Index as well as certain exchange-traded funds.
The circuit breakers reflect a consensus that was achieved after Chairman Schapiro convened a meeting of exchange leaders and FINRA at the SEC shortly following the events of May 6. The Commission, along with the exchanges and FINRA, has been monitoring the operation of the circuit breakers since their implementation.
While the circuit breakers have been effective in moderating potentially extraordinary volatility, they also have been triggered by erroneous trades. As a result, Chairman Schapiro has encouraged the exchanges and FINRA to develop a more sophisticated mechanism that not only would prevent an erroneous trade from triggering a trading pause, but keep the erroneous trade from occurring in the first place.
“The circuit breakers for individual securities across the exchanges helped to limit significant volatility and bring uniformity to decisions regarding trading halts in individual stocks,” added Chairman Schapiro. “But we felt that we could improve upon the system, and have been working with the exchanges and FINRA since the adoption of the single-stock circuit breaker pilot program to develop improved mechanisms, such as a limit up-limit down process, to limit extraordinary market volatility.”
Other Post-May 6 Actions
The SEC has undertaken other initiatives to respond to the events of May 6, 2010, including the approval of exchange rules that eliminate market maker stub quotes and the establishment of a pilot program by the exchanges and FINRA to establish clear and objective standards for breaking erroneous trades.
The SEC staff also is continuing to work with CFTC staff and the markets to consider recalibrating market-wide circuit breakers currently on the books – none of which were triggered on May 6. These circuit breakers apply across the securities and futures markets.
The SEC has adopted other market structure measures including a rule requiring broker-dealers to have risk controls in place before providing their customers with access to the market. And the agency has proposed a rule to establish a consolidated audit trail system to better track orders and trades in securities across the national market system.
The proposed plan will be available on the SEC’s website. The Commission intends to promptly publish the proposed plan in the Federal Register for a 21-day public comment period, and then determine whether to approve it shortly thereafter.