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Circuit Breakers May Be First Step in Slowing Stocks

A circuit-breaker test will pause trading for five minutes when a company rises or
falls 10 percent in five minutes or less. Photographer: Daniel Acker/Bloomberg
A circuit-breaker test will pause trading for five minutes when a company rises or falls 10 percent in five minutes or less. Photographer: Daniel Acker/Bloomberg

The U.S. Securities and Exchange Commission’s plan to impose halts on stocks that swing more than 10 percent may be followed by more measures to slow trading.

The circuit-breaker test, a response to the May 6 plunge that wiped out $862 billion of share value in 20 minutes, began as a pilot covering five stocks and is scheduled to expand next week. SEC Chairman Mary Schapiro said yesterday the agency is considering regulating the speed of stock orders as part of a broader effort to rein in electronic markets.

Regulators are under pressure from investors and lawmakers to show they have a grip on markets increasingly dominated by computers trading thousands of shares in less than a second. Different rules on as many as 50 American equity venues helped exacerbate the May 6 selloff as some platforms were overwhelmed with electronic instructions to sell shares.

The SEC needs “to explore whether bids and orders should be regulated on speed so there is less incentive to engage in this microsecond arms race that might undermine long-term investors and the market’s capital-formation function,” Schapiro said yesterday at a conference in Montreal. “The markets have to serve that function for companies to raise money, create jobs and allow the economy to grow.”

Five Minutes

The circuit-breaker test, scheduled to last through Dec. 10, will pause trading for five minutes when a company rises or falls 10 percent in five minutes or less. The curbs apply between 9:45 a.m. and 3:45 p.m. New York time. The New York Stock Exchange began implementing them today after delaying the program last week.

NYSE Euronext said five stocks -- EOG Resources Inc., Genuine Parts Co., Harley-Davidson Inc., Ryder System Inc. and Zimmer Holdings Inc. -- will be covered by the halts today, according to a statement on its website. The remaining 399 Standard & Poor’s 500 Index companies that NYSE lists will be subject to the rules by June 16 -- with 54 on June 14, 172 more on June 15 and the final 173 the final day, the exchange said.

Nasdaq OMX Group Inc. will activate the program with all of its S&P 500 stocks on June 14, spokesman Robert Madden said in an e-mailed statement yesterday.

As many as 250 exchange-traded funds will also be added to the pilot, according to James Ross of State Street Global Advisors, the second-biggest manager of ETFs. Ross, a senior managing director at the firm, spoke in an interview from New York, citing industry discussions with the SEC. John Heine, an SEC spokesman, declined to comment.

Dark Pools

Schapiro, speaking at an International Organization of Securities Commissions event yesterday, said the SEC is examining whether electronic venues known as dark pools, which don’t display public quotes, are preventing stocks from trading at their appropriate prices.

“We are also looking at whether and to what extent pre- trade price discovery is impaired by the diversion of desirable, marketable order flow from public markets to dark pools,” she said.

The SEC proposed rules in October that would limit the ability of dark pools to seek new orders to match existing ones without displaying prices. The agency is also considering eliminating flash orders, or pricing data shown a split-second early to a segment of market participants.

ETF Trading

BlackRock Inc. in New York and Valley Forge, Pennsylvania-based Vanguard Group Inc. said ETFs, which made up 70 percent of securities with trades on May 6 that were later canceled because of excessive declines, shouldn’t be omitted from the circuit-breaker pilot. Vanguard’s mutual funds had $1.42 trillion in assets as of March 31, while BlackRock’s had $3.36 trillion, making it the world’s biggest money manager.

Schapiro has pledged to increase the scope of the pilot to “thousands” of additional public companies.

“BlackRock has been informed by a number of large liquidity providers that when the steep decrease in U.S. equity values neared 10 percent -- a level specified as a ‘reference’ in exchange erroneous trade rules -- the liquidity providers steeply discounted or ceased their bids for ETFs,” the firm said in a June 2 letter to the SEC. Companies “pulled back from bidding for shares of ETFs that owned high percentages of stocks perceived as vulnerable to cancellations,” BlackRock said.

The SEC said in a joint report with the Commodity Futures Trading Commission on May 18 that ETFs were the securities most affected by the May 6 plunge. ETFs, whose price is based on the value of the shares they include, declined because the price of underlying stocks decreased. The inability of market makers to hedge their trades on May 6 by buying and selling the constituent stocks may also have “contributed to a lack of liquidity in ETF shares,” regulators found.

“If a stock within an ETF halts and the ETF continues to trade, market makers will back away from the ETF and stop making markets,” Gus Sauter, chief investment officer at Vanguard, said in an interview. This applies to firms with specific trading obligations called designated market makers on NYSE and “unofficial people making markets” on other venues, he said.

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