SEC Staff Prepares Price Curb Recommendations, Shillman Says

U.S. Securities and Exchange Commission staff members are preparing recommendations on how to revise curbs that limit price swings or halt trading in markets, an agency official said today.

The SEC implemented the constraints after the May 6, 2010, plunge that briefly erased $862 billion in U.S. equity values. They include circuit breakers for individual equities and marketwide curbs that halt all securities and futures trading during larger slumps. The SEC must issue a final rule for any new regulation to go into effect.

“We’ll be in a position to make recommendations to the commission in the next month or so,” David Shillman, an associate director at the SEC, said at a Washington securities-law conference today. The SEC has been working with the Financial Industry Regulatory Authority on modernizing the limits that apply across all markets, Shillman said. The staff will present the two recommendations together, he said.

While the circuit breakers that pause trading when a company’s shares move 10 percent in five minutes have worked “relatively well,” since they were adopted, about half were triggered by trades deemed erroneous, Shillman said. The new plan will prevent errant trades from halting shares, he said.

“We need to develop a more sophisticated mechanism,” he said. He added that the current halting mechanism has been a “blunt instrument.”

NYSE, Nasdaq

The New York Stock Exchange, Nasdaq Stock Market and other venues are working with regulators on the project to switch from individual curbs that immediately halt trading when shares move rapidly to a so-called limit-up/limit-down plan that prevents trades outside a moving price band based on a security’s average level in the past five minutes. The SEC announced the proposal by the exchanges and Finra in April. That program also includes a provision that halts stocks for five minutes, like the current circuit-breaker system.

Proposals for curbing volatility in individual shares and changing the halt mechanism that applies to the broader market were recommended by advisers to the SEC and Commodity Futures Trading Commission in February 2011. They included Joseph Stiglitz, an economist who won the Nobel Prize; David Ruder, a former SEC chairman; Brooksley E. Born, who was chairman of the CFTC; and John J. Brennan, chairman emeritus and senior adviser at Vanguard Group Inc.

Regulators and exchanges are overhauling rules adopted a quarter century ago to shut down the equity market and related futures trading during periods of volatility. The marketwide circuit breakers didn’t halt trading on May 6, 2010, when the Dow Jones Industrial Average dropped dropped 9.2 percent in what came to be known as the flash crash.

S&P 500, Dow

Exchanges have suggested that the curbs be triggered when the Standard & Poor’s 500 Index falls 7 percent. The circuit breaker is currently set off when the Dow drops 10 percent. The proposal also shortens the length of most halts.

Changes to the marketwide volatility curbs and the planned shift from individual-stock circuit breakers to a system that limits price moves without immediately halting trading should work together, the Securities Industry and Financial Markets Association said in a letter to the SEC in October.

The group said the new standards should also “be coordinated with trading halts in the futures markets.” If not, the changes to the marketwide circuit breakers “will be seriously undermined,” Sifma said.

CFTC commissioner Bart Chilton told the SEC in a letter in October that he was “apprehensive” about how a market plunge would affect the interaction between the curbs for individual stocks and the broader market. The interplay of those restraints may fuel uncertainty, make it harder for investors and brokers to manage risk and “cause liquidity providers to leave the market when they are needed the most,” he said.

Keeping Records

The SEC may also extend the deadline for brokers to comply with a rule requiring them to track data on transactions by large traders, Shillman said at the conference today. The regulation, approved in July, calls for securities firms to maintain records and report and monitor the activity of large traders using identification codes starting on April 30.

Robert Cook, the SEC’s director of trading and markets, said in an interview that discussions about extending the deadline are under way.

Large traders are those that transact at least 2 million shares or $20 million of securities in a day, or 20 million shares or $200 million in a month, according to the SEC rule. The single-day share figure represents less than 0.03 percent of the average daily U.S. equities volume of 7.8 billion shares last year, data compiled by Bloomberg data show.

Consolidated Audit Trail

The framework for another SEC effort, which would implement a marketwide surveillance system to track equity trading activity, “are being finalized,” SEC Chairman Mary Schapiro said today. She added that the system, called a consolidated audit trail, “should eventually be expanded to include fixed income, futures and other markets.”

Schapiro last week backed away from the SEC’s aim to require live reporting of trading data as part of the audit trail. Nester said in a statement on Feb. 9 that Schapiro though the benefits of the market-surveillance system could be gained “without incurring the costs and risks of real-time reporting.”

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