SEC looks at stub quote ban after flash crash

By Reuters
Posted Sep. 8, 2010 at 2:12 p.m.

Regulators probing the stock market “flash crash” in May still have not uncovered a single cause but will point to “stub quotes” and other previously identified issues as having exacerbated the market’s dramatic drop, according to two sources familiar with the probe.

A third source said the Securities and Exchange Commission is still asking about a “smoking gun” that might explain the May 6 crash, when the Dow Jones industrial average plunged some 700 points before sharply recovering, all in about 20 minutes.
“Quote stuffing,” in which large numbers of rapid-fire stock orders are placed and canceled almost immediately, will not be fingered as one of the causes of the crash, sources have said.

But the SEC is increasingly probing market data from other trading days, looking for possible problems with what are sometimes excessive numbers of buy and sell orders, said the third source. The worry is that such a flood of orders could clog data feeds and confuse investors, giving the sender an unfair advantage to arbitrage between marketplaces.

Quote stuffing, a new term describing this possibly illegal trading practice, differs from stub quotes, which are orders placed well off the market prices for stocks.

Regulators are soon due to issue a follow-up report on the crash, which rattled investors worldwide and exposed flaws in the high-speed electronic marketplace.

So far, the report by market regulators does not contain a lot of new information and is expected to repeat earlier findings that a number of events caused the crash, two sources said. The sources requested anonymity because regulators are still collecting data and completing the report.

The sources said the report will point to stub quotes as one of the structural issues that contributed to the plunge.

The SEC has adopted a pilot program to help prevent a repeat of the crash. That circuit-breaker program pauses trading in a single stock when it’s  in crisis and has tripped several times since it started in June.

The SEC also wants to ban stub quotes and is expected to propose such a rule soon.

For months, the SEC and other market regulators have grappled with half a dozen hypotheses to explain the flash crash. They have probed links between declines in prices of stock index products and the severe mismatch in liquidity, among other things.

Though regulators still cannot explain what went wrong, they are considering new rules to solve problems exposed by the flash crash.

In addition to the single-stock circuit breakers and stub quote ban, the SEC wants to tighten rules for market makers to ensure liquidity in stressful times.

The SEC is also mulling updates to its broader circuit breakers to give markets a brief reprieve should they plunge uncontrollably. Current marketwide circuit breakers were not triggered in the May crash.

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