SEC Sends Subpoenas in Probe of Stock-Market Drop
U.S. Securities and Exchange Commission Chairman Mary Schapiro said the agency’s enforcement unit has issued subpoenas in an investigation of last week’s stock plunge.
The division is “fully integrated in our review of the events of May 6 and will recommend appropriate action” if violations are found, Schapiro told a House Financial Services subcommittee yesterday. “A number of subpoenas” were sent, she said, without identifying recipients.
SEC investigators began preparing for a variety of inquiries in the hours after the Dow Jones Industrial Average briefly dropped as much as 9.2 percent, people familiar with the matter said last week. Commodity Futures Trading Commission Chairman Gary Gensler said one trader’s sales of index futures accounted for nine percent of the volume during the plunge. Regulators haven’t found evidence the incident was triggered by hackers, terrorists, malicious traders or a so-called fat finger entering an oversized order, Schapiro told lawmakers.
The SEC is also concerned that firms or exchanges may have lacked required controls to prevent the rout from snowballing, people familiar with the matter said. It will also look at whether traders tried to take advantage of the chaos by steps such as entering orders that drove down some stocks.
“We may learn that the extraordinary disruption in trading, however it may have been triggered, was the result of a confluence of events which, taken together, exacerbated what already had been a down day,” Schapiro said yesterday. “We are not prepared at this time to draw that conclusion.”
Schapiro and executives at NYSE Euronext and Nasdaq OMX Group Inc. agreed that all venues need uniform halts to shut down trading during investor panics. Though regulators and exchanges dispelled rumors about what caused stocks to plunge, examinations of trading data haven’t yielded firm conclusions about what did, Schapiro said in her prepared testimony.
The SEC and CFTC face pressure to show they have a grip on increasingly fragmented markets dominated by computerized trading of stocks and futures. Representative Paul Kanjorski, who leads the House panel, called the hearing to scrutinize whether technology and competition for NYSE and Nasdaq contributed to the free fall in stock prices.
“As old trading methods have given way to modern techniques, the rules governing our market architecture have lagged behind,” said Kanjorski, a Pennsylvania Democrat. “The markets were hardly fair or orderly during last Thursday’s roller-coaster ride.”
Heavy trading in Standard & Poor’s 500 Index futures and data communication problems between electronic exchanges helped trigger the plunge, said Eric Noll, Nasdaq’s executive vice president for transaction services.
While the market-wide stock drop matched the decline in the S&P 500 E-mini, a Chicago Mercantile Exchange-traded future that tries to mirror what the price of the benchmark index will be a month from now, Schapiro said it couldn’t be determined whether trading in the contract helped caused the rout.
“The fact that stocks prices follow futures prices chronologically does not demonstrate what may have triggered the price movements,” she said yesterday.
The CFTC is examining the 10 traders holding the biggest long positions in the S&P 500 E-mini and the 10 traders with the biggest shorts on the future, Gensler said. Most bought and sold during the period in question, while one “was using the E-Mini contract to hedge, and only entered orders to sell,” he said in his prepared testimony. The trader sold on the way down, and continued to sell as prices recovered, Gensler said.
The agency sent letters to market participants seeking data on their positions and “all communications related to trading” on May 5 and May 6, he said.
The Dow on May 6 took its biggest tumble since the crash of 1987 before paring losses and closing down 3.2 percent. About $700 billion was erased from U.S. equity markets during an eight-minute span after the NYSE took actions to slow trading, data compiled by Bloomberg show.
CNBC cited “multiple sources” in reporting that day that New York-based Citigroup Inc. may have made a mistake in entering a transaction. Citigroup spokeswoman Danielle Romero- Apsilos said “rumors about a trading error by Citi are unfounded.”
Cincinnati-based Procter & Gamble Co., the world’s biggest consumer products company, fell as much as 37 percent on May 6 for the biggest intraday drop among Dow industrials.
Evidence reviewed by regulators so far doesn’t indicate that an offer to sell Procter & Gamble or an erroneous trade triggered the temporary slump in financial markets, Schapiro said.
In a May 10 meeting, the SEC and exchanges discussed market-wide circuit-breakers that would halt trading for 15 minutes whenever the S&P 500 fell 5 percent, Noll said. The proposal would shut trading for an hour when the index lost 10 percent and close markets for the rest of the day when it fell 20 percent, he said.
Schapiro also said regulators would impose stock-by-stock halts to stop trading in individual companies that have fallen a certain percentage.
Noll and NYSE Euronext Chief Operating Officer Lawrence Leibowitz said they support halts in trading for individual stocks once they have fallen 10 percent. When asked by Representative Scott Garrett what he thought of a 2 percent threshold, Noll said it would be “too tight.” Garrett is a New Jersey Republican.
Taxes on Traders
The exchanges submitted recommendations to the SEC yesterday “outlining the counters” of circuit-breakers for the entire market and individual stocks, agency spokesman John Nester said. Trading venues also made recommendations on how “clearly erroneous trades” should be handled, he said. Schapiro, SEC commissioners and agency staff will review the proposals over the next few days, Nester said. He declined to comment on the specific percentages that exchanges recommended for circuit-breakers.
Representative Brad Sherman questioned whether new regulations or taxes should be imposed on high-frequency traders, market participants who use computer algorithms to trade thousands of shares a second.
Sherman, a California Democrat, said he’s concerned that regulators and exchanges will “patch up the current system” to restore investor confidence without addressing the risks that some traders pose.
High-frequency traders pulled out of the market precisely when stocks experienced their steepest decline, indicating they contributed to a loss of liquidity, Gensler said.
Leibowitz defended high-frequency traders, saying their computers fill a role of providing markets for buyers and sellers that was once served by “physical people.” High- frequency traders who serve as designated market makers supply 10 percent of the NYSE’s liquidity, he said.
“We would be stunned by the consequences” if regulators banned high-frequency trading, Leibowitz said.
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