The United States Securities and Exchange Commission (SEC) recently approved two proposals submitted by the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) that are designed to address extraordinary volatility in individual securities and the broader U.S. stock market. The first proposal creates a “limit up-limit down” device to prevent certain individual stocks from trading outside an established price band. The second proposal updates existing market-wide circuit breakers that, when triggered, halt trading in all exchange-listed securities throughout the U.S. markets. Behind these changes are the events of May 6, 2010.
On May 6, 2010, there was a severe disruption and abnormal volatility in the U.S. stock markets. Some securities experienced severe price declines before increasing back to to their pre-decline price levels. Many trades were executed at the temporarily depressed price levels. Also, market-wide circuit breakers that had been put in place in response to the October, 1987, crash were not triggered.
The “limit up-limit down” mechanism prevents trades in individual listed equity securities from occurring outside of a specified price band. The band would be set at a percentage level above and below the average price of the security over the immediately preceding five-minute period.
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. Also, under the new plan, all trading centers, including exchanges, automated trading venues, and broker-dealers executing trades internally must establish policies and procedures to prevent trades from occurring outside the applicable price bands, honor any trading pause, and otherwise comply with the procedures set forth in the plan.
The revised market-wide circuit breaker rules update the existing rules by:
• Reducing the market decline percentage thresholds needed to trigger a circuit breaker to 7, 13, and 20 percent from the prior day’s closing price, rather than declines of 10, 20, or 30 percent.
• Shortening the duration of trading halts that do not close the market for the day to 15 minutes, from 30, 60, or 120 minutes.
• Simplifying the structure of the circuit breakers so that there are only two relevant trigger time periods, those that occur before 3:25 p.m. and those that occur on or after 3:25 p.m. The two periods replace the current six-period structure.
• Using the broader S&P 500 Index, rather than the Dow Jones Industrial Average, as the pricing reference to measure a market decline.
• Requiring the trigger thresholds to be recalculated daily rather than quarterly.
In addition to the single-stock circuit breaker pilot program, the SEC has undertaken other initiatives in the wake of May 6, including:
• Approving new exchange and FINRA rules clarifying how and when erroneous trades would be broken.
• Approving new exchange and FINRA rules to strengthen the minimum quoting standards for market makers and effectively prohibit “stub quotes” in the U.S. equity markets.
• Adopting a rule requiring broker-dealers to have risk controls in place before providing their customers with access to the market.
• Adopting a rule establishing a large trader reporting system to enhance the Commission’s ability to identify large market participants and collect information on their trading activity.
These changes are set to be implemented by February 4, 2013. You can access the entire announcement at the following link: http://www.sec.gov/news/press/2012/2012-107.htm
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