Tighter rules for market makers post-’flash crash’

By Reuters
Posted Sep. 17, 2010 at 4:30 p.m.

U.S. stock exchanges proposed tighter rules for stock “market makers” Friday meant to ensure they provide more useful liquidity in stressful times such as the May “flash crash.”

The proposals, submitted to regulators, would effectively eliminate so-called stub quotes that are priced well off the public price of stocks. They would also force market makers to quote no more than 8 percent away from the price of stocks covered under new circuit breakers.

The flash crash was exacerbated in part because market markers and other big trading firms stopped trading, sapping the market of buy orders when nearly everyone scrambled to sell. At the depth of the 20-minute crash, scores of trades were executed for as little as a penny, the stub orders.

The proposals were crafted by the major stock markets, including the New York Stock Exchange after weeks of consultation with the Securities and Exchange Commission. The SEC has yet to fully explain the crash, but says such rules should help prevent a repetition.

Market makers are firms required to provide both buy and sell orders, or quotes, in specific stocks on the exchanges on which they are registered. The proposals would ensure these quotes stay within specific bands.

The 8 percent band, reported by Reuters in July, relates to stocks covered under the recently launched single-stock circuit breakers — another reaction to the May 6 crash.

More than 1,000 stocks and exchange-traded funds are covered under the circuit breaker rules, which pause trading when the most liquid securities move more than 10 percent. They include all stocks in the S&P 500 and the Russell 1,000 index.

For other stocks, market makers are forced to quote within a 30 percent band, according to the proposals.

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