SEC probes big trading firms’ role in stock plunge

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Federal regulators said Monday they are looking at whether big trading firms abandoned the market during the massive sell-off on May 6 rather than providing cash support required under law.

Staff of the Securities and Exchange Commission said the possible retreat of big “liquidity providers” during the market plunge is an area of focus in the investigation. Major firms are required by law to remain in the market by buying and selling stocks; smaller firms are not.

Staff members of the SEC and the Commodity Futures Trading Commission were presenting their findings at the first meeting of the two agencies’ special advisory committee. The panel is examining the freefall that sent the Dow Jones industrials down nearly 1,000 points in less than 30 minutes.

SEC Chairman Mary Schapiro said the market chaos of May 6 “undermined investors’ faith” in the integrity of the securities markets.

The regulators and U.S. securities exchanges have a plan to keep it from happening again, proposing essentially that markets call a “time out” when trading gets too chaotic.

The big stock exchanges say that new curbs on trading known as “circuit breakers” will help prevent runaway market drops. But not everyone is convinced. Some market watchers says the proposed rules are too limited; others say they go too far.

The SEC unveiled the plan for circuit breakers last week w ith support from the exchanges. 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 idea is that circuit breakers would give investors a break during extreme market dips, and possibly head off a chain reaction of human and computerized selling.

That’s one of several possible causes of the May 6 plunge. The drop briefly wiped out $1 trillion in market value as some stocks traded as low as a penny.

Investigators are focusing on a possible link between the steep decline in prices of stock indexes, and “simultaneous and subsequent” waves of selling in individual stocks.

Also being looked at is a “severe mismatch” of liquidity in the market that may have been worsened by the withdrawal of electronic traders and the use of so-called “stop-loss” market orders, a new report by staff of the SEC and CFTC said. Stop-loss orders set the price at which a stock is automatically sold when it declines to a specified level.

- Associated Press