The transaction that halted Citigroup Inc. for five minutes on June 29 is spurring a review of brokerage controls meant to prevent errant trades, according to Thomas Gira of the Financial Industry Regulatory Authority.
Finra is analyzing the trade, in which 8,820 shares crossed at $3.3174, or 13 percent below the previous price, triggering curbs designed to keep rapid moves from proliferating. Citigroup was the second company to set off halts installed after the May 6 plunge that wiped out $862 billion of equity value in 20 minutes. The order was processed manually by a broker, said Gira, Finra’s executive vice president for market regulation.
The Citigroup transaction, which occurred off exchange and was canceled, is prompting Finra to increase its focus on ensuring that brokers have controls to prevent bad orders from disrupting the market. Gira said the group, which oversees almost 4,700 firms, expects to complete an analysis soon into what caused the broker to process the shares and which controls were in place to prevent such a trade from executing.
“Isolated errors happen because of human error or system malfunction,” Gira said. “But with trading pauses, that raises this to a higher level of focus for us. In the past when a firm had an error, it didn’t shut down the market for five minutes.”
Gira declined to identify the firm that executed the Citigroup trade. The order at 1:03:51 p.m. in New York on June 29 was submitted to the Finra/Nasdaq trade reporting facility, or TRF, which records the majority of over-the-counter transactions. The stock climbed back to $3.80 when trading resumed five minutes later. Almost 800 million Citigroup shares traded that day, with more than 43 percent off exchange.
When a stock rise or falls at least 10 percent in five minutes, trading in the shares is temporarily halted across all markets, under the circuit breaker program.
“We’re looking at the circumstances surrounding the trade and validating that it really was an error and the firm has adequate procedures in place,” Gira said. While the examination isn’t yet complete, “this is a very high priority,” he said.
About a third of equity volume occurs away from exchanges and is printed to one of the two TRFs Finra runs with NYSE Euronext’s New York Stock Exchange and Nasdaq OMX Group Inc.’s main market. That includes “manual” buy and sell requests handled by human traders at firms such as Morgan Stanley, Barclays Plc and Bank of America Corp., and executions in dark pools, which are private venues that don’t display bids and offers publicly. Brokers that operate as market makers and execute customer orders within their walls also report their activity to one of the TRFs.
If Finra finds reason to take formal action against the broker whose trade halted Citigroup, that information would be made public, Gira said. The regulator could also issue a notice advising members on best practices to prevent erroneous trades from occurring, he said.
“An error in and of itself isn’t a rule violation, but we’d be concerned if we see recidivism with firms that are having errors,” Gira said. “If a firm has inadequate controls in place, that could indicate a more systemic problem.”
Brokers are obligated to implement “reasonable procedures” to avoid error trades, Gira said. They can vary by the type of trading overseen, such as automated or manual executions. “Prices relative to last sale and prices relative to the national best bid or offer are reasonable checks,” Gira said. “If a firm sees a trade that’s significantly away, it should do due diligence to make sure it’s a valid trade.”
Finra is also reexamining the “validation checks” conducted on all over-the-counter transactions sent to the TRFs. The Citigroup trade didn’t meet the price threshold that flags potentially problematic trades, Gira said. The checks were in place before the new circuit breakers were introduced.
“We’re looking at those levels to make sure there are good protections in place,” Gira said. The triggers are scaled based on a stock’s price so trades in $5-$10 shares must have larger dollar moves to be flagged than those in the $1-$5 range. “We’re revisiting those levels now,” he said.
The circuit breakers that apply to S&P 500 stocks will soon expand to Russell 1000 Index companies and to more than 300 exchange-traded funds. Brokers and firms such as Credit Suisse Group AG, Getco LLC, and Allston Trading LLC have suggested the Securities and Exchange Commission consider an alternate mechanism that prevents trading below a specified level instead of halting all transactions when a circuit breaker is triggered.
The agency is also considering mechanisms such as price collars on buy and sell orders that could otherwise transact at any level to prevent unintentional executions from occurring a significant amount away from the market, according to SEC Chairman Mary Schapiro. Several venues including Bats Exchange and the Chicago Mercantile Exchange, the world’s largest futures market, employ these features to avoid trades that might have to be canceled. CME Group Inc. runs the Chicago futures exchange and Bats Global Markets operates the equities venue.
The first stock to trigger a trading pause under the circuit breakers was Washington Post Co., which doubled in price on June 16 before the executions on NYSE Arca were canceled. On July 6, trading in Anadarko Petroleum Corp. was halted after a 200-share order crossed on NYSE Arca at $100,000, up from $39.16. The transaction was voided, according to data compiled by Bloomberg. Arca is operated by NYSE Euronext.
“Everyone will have to take a step back and figure out if they have adequate procedures in place to avoid erroneous trades,” Gira said. “The consequences are now more significant than they were before.”