SEC probing flood of orders in U.S. stock market-UPDATE 3
Trade the News
Wednesday September 08, 2010 06:53:19 PM GMT
* 'Flash crash' report due near end of month -Schapiro
* May 6 crash still unexplained, sparked some new rules
* No timeline provided for market structure rule adoption (Adds Schapiro comments to reporters, Nasdaq CEO, market maker background)
By Jonathan Spicer and Herbert Lash
NEW YORK, Sept 7 (Reuters) - U.S. regulators are looking for possible fraud related to the large numbers of rapid-fire stock orders that are placed and canceled almost immediately, a common practice in today's markets, Securities and Exchange Commission Chairman Mary Schapiro said on Tuesday.
Schapiro, addressing the Economic Club of New York, broadened the already wide array of issues the SEC is looking at in the wake of the flash crash, including the fact that some firms regularly send more than 90 buy or sell orders for every trade they ultimately make.
"People don't realize the velocity of trading and the volume of trading at the multiple venues that exist," Schapiro told reporters on the sidelines of the luncheon.
"I thought it would be helpful to give people a sense of what the numbers tell us."
Regulators are looking at what has recently come to be called "quote stuffing" -- the flooding of markets with bogus orders -- in connection with the mysterious May 6 "flash crash," when the Dow Jones industrial average dropped dramatically before quickly recovering.
"The SEC and other regulators are looking carefully at certain practices in this area to assess whether they violate existing rules against fraudulent or other improper behavior," Schapiro said in her address.
"Quote stuffing" is not seen as the cause of the dramatic market drop, sources have said. A report that may explain the flash crash is expected toward the end of the month, Schapiro told Reuters before delivering the speech.
Regardless, the SEC has introduced a pilot "circuit breaker" program that pauses trading in a single stock if that stock is in a free fall. Schapiro said the circuit breaker program -- which stops trading for five minutes if a stock falls more than 10 percent in five minutes -- can be improved.
"Currently, the circuit breakers can be triggered by anomalous trades that may not warrant pausing all trading in the stock for five minutes," Schapiro said.
Schapiro said the SEC's next steps are likely to include a careful review of a limit-up and limit-down procedure that would directly prevent trades outside specified parameters, while allowing trading to continue within those parameters.
A limit-up and limit-down rule, used in futures markets, is seen as a possible alternative to circuit breakers.
Elsewhere, Schapiro said new rules for registered market makers -- firms that take both sides of the market, providing liquidity -- should be considered. She later told reporters the SEC is in the early stages of considering what benefits these firms should receive in return for obligations.
'EVOLUTION, NOT REVOLUTION'
The SEC has undertaken a review of the structure of markets, which has changed dramatically over the years. Robert Greifeld, chief executive of exchange operator Nasdaq OMX Group Inc, told reporters at the luncheon that the wide-ranging debate represents an "evolution, not revolution" in market structure.
Quote stuffing is a term coined by Nanex LLC, a trade database developer that issued a study suggesting computer algorithms did this to gain an edge during the May 6 crash. The study argued that high-frequency traders regularly use the bogus orders to distract rival trading firms and to create profitable arbitrage opportunities between marketplaces.
Investors could make trades under the false impression that those orders were legitimate, only to see liquidity disappear and the market move against them when the orders are canceled -- all in the blink of an eye.
The SEC is looking at the rules for high-frequency traders. The flash crash threw the rapid trading industry in the spotlight, triggering some lawmakers to call on the SEC to rein in the practice.
On Tuesday, New York Senator Charles Schumer urged the SEC to consider new rules to slow the rapid trades when the market is volatile. Schumer, who sits on a committee that oversees the SEC, said the regulator should consider imposing a minimum quote duration so orders cannot be sent and canceled in a fraction of a second.
Schumer has inserted himself in other market structure issues and last year called on the SEC to ban flash orders, which give advance knowledge of stock orders to some traders.
The SEC has since proposed a ban on the flash orders. The agency has also proposed ways to shed light on anonymous venues known as dark pools, where much institutional trading is done.
The SEC is trying to adopt the rules before they are forced to craft about 100 rules under the Dodd-Frank financial regulation bill. Schapiro did not provide a timeline for the market structure rules. (Reporting by Jonathan Spicer, Herbert Lash and Rachelle Younglai; Writing by Rachelle Younglai and Jonathan Spicer; Editing by Tim Dobbyn, Maureen Bavdek, Gary Hill)
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