Trades Reflecting `Errors' Were Broken in Stock Plunge, Nasdaq's Noll Says
Canceling trades in stocks that fell 60 percent during last week’s plunge reflected a policy to erase pricing “errors,” said Eric Noll, executive vice president for transaction services at Nasdaq OMX Group Inc.
Nasdaq broke 10,468 trades representing 1.4 million shares in 236 securities that occurred as equities tumbled, according to Noll. NYSE Arca and electronic venues reversed transactions in hundreds of stocks after the Dow Jones Industrial Average fell 9.2 percent, the biggest decline since the crash of 1987.
Exchange officials had a “significant debate” about where to set the threshold in a call after the selloff, according to Noll’s congressional testimony today. Chief executive officers of the biggest U.S. trading venues who met with the Securities and Exchange Commission in Washington yesterday agreed to submit proposals for overhauling erroneous-trade policies, according to two people with knowledge of the matter.
“Trade break authority exists to nullify trades that take place in market conditions where errors, be they human or technological, or other unanticipated events, preclude fair and proper price-discovery,” Noll said. “It is important to remember that every trade has two parties. Generally one will be happy to break the trade and avoid a loss while the other will want to keep his trade.”
Some securities professionals criticized the 60 percent cutoff for determining which transactions were wiped out. Packy Jones, chief executive officer and chairman of JonesTrading Institutional Services LLC, said in an interview that the trades shouldn’t have been canceled.
Accenture Plc and Exelon Corp. were among U.S. stocks that dropped more than 90 percent as U.S. equities tumbled, before recovering within minutes, according to Bloomberg data. Officials usually consider breaking trades deemed erroneous when they are 3 percent or more away from the market price, according to exchange guidelines.
“I’ve never seen a day where the exchanges gave everyone a mulligan,” Jones said. His company, an institutional broker based in Westlake Village, California, didn’t have to break any trades. “It’s not a real market if you can cancel a trade because you don’t like it,” he said.
Almost 1.3 billion shares traded on U.S. exchanges in a 10- minute span starting at 2:40 p.m., six times the average rate, sending prices lower on venues from New York to Kansas City and Chicago and erasing $700 billion in value. Most of the rout was subsequently reversed as the Dow average pared a 998.5-point drop into a decline of 347.8 points.
The 60 percent cutoff meant that trades in Cincinnati-based Procter & Gamble Co., which fell as much as 37 percent for the biggest intraday drop in the Dow industrials, would stand. SEC Chairman Mary Schapiro said the agency found no evidence of “unusual” trading in shares of the world’s biggest consumer products company, according to a transcript of her testimony.
“To sit there and arbitrarily pick a number and say, ‘OK, if it goes down X we’re going to cancel these trades out’ -- how do you come to that number and why is that?” said Jason Cooper, who manages $2.5 billion at 1st Source Investment Advisors in South Bend, Indiana. He said he’d be “a little bit upset” if he was on the profitable side of a trade that was canceled.
Breaking trades causes “tremendous problems” for firms making investment decisions, said Fred Federspiel, chief executive officer of Pipeline Trading Systems LLC, a New York- based broker and operator of a trading venue that doesn’t display quotes publicly. If one part of a multipiece trade is canceled, that could alter the whole trade’s risk, he said. Pipeline didn’t break any trades on May 6, he said.
Nasdaq’s Robert Madden, Direct Edge Holdings LLC’s Rafi Reguer and NYSE Euronext’s Ray Pellecchia declined to comment on the threshold. New regulations will strengthen the definition and handling of erroneous trades, Schapiro said in her testimony.
Breaking trades creates the risk that investors will take bigger chances in the future, believing they will be bailed out, said Andrew Brenner, president of U.S. operations at Belzberg Technologies Inc., a Toronto-based provider of trading systems and services. Brenner is the former head of the ISE Stock Exchange, a market founded by the International Securities Exchange Holdings Inc. and now operated by Direct Edge in Jersey City, New Jersey.
While rules about when to break trades are a good idea, exchanges may struggle to find a “pre-set benchmark” for cancellations since situations warranting that decision can’t always be predicted, he said.
“How do you arrive at 60 percent?” said Brett Mock, the San Francisco-based chairman of Security Traders Association, a trade group for employees of brokers and asset management firms. “Taking trades off the tape is a very bad standard.”