Federal report: 1 huge trade set off market's 'flash crash' in May
10/2/2010WASHINGTON - A trading firm's use of a computer sell order triggered the May 6 market plunge, which sent the Dow Jones industrial average careening nearly 1,000 points in less than 30 minutes, federal regulators said Friday.
A report by the Securities and Exchange Commission and the Commodity Futures Trading Commission determined the so-called "flash crash" occurred when the trading firm executed a computerized selling program in a stressed market.
The firm's trade, worth $4.1 billion, led to a chain of events that ended with market players swiftly pulling their money from the stock market, the report said.
The report did not make recommendations, but it lays the foundation for a special panel to propose rules to avoid a repetition.
The report does not name the trading firm, but only one trade that day fit the description in the report. The firm Waddell & Reed, based in Overland Park, Kan., has acknowledged making such a trade that day.
SEC officials declined to comment on whether they were investigating Waddell for any wrongdoing.
The free-fall highlighted the complexity and perils of fast-evolving securities markets. Computers using mathematical formulas give "high frequency" traders a split-second edge. Electronic errors at high speeds can ripple through markets.
The market was stressed even before that day's plunge. Anxiety mounted over Europe's debt crisis.
The Dow Jones had been down about 2.5 percent at 2:30 p.m., when the trader placed an enormous sell order on a futures index of the S&P's index, called the E-Mini S&P 500. The trade was automated by a computer algorithm that was trying to hedge its risk from price declines. In that one trade, 75,000 contracts were sold within 20 minutes.
It was the largest trade of that investment since the year began. The firm's previous transaction of that size took more than five hours, the report notes.
The trade triggered aggressive selling of the futures contracts, and that sent the index sinking about 3 percent in four minutes. The report said the trading formula's design may have amplified the rush to sell. It said the formula ignored price changes and responded to the volume of trading.
The firm maintained the transaction "was not the cause of any abnormal price action." The trade was proper, Chicago Mercantile Exchange Inc. said.
Nearly 21,000 trades were canceled in ensuing weeks because the exchanges deemed them erroneous.
And the SEC and the major U.S. exchanges agreed on a pilot program that briefly halts trading of stocks that mark big price swings. The "circuit breakers" are in effect until Dec. 10.
Rep. Paul Kanjorski (D., Pa.), who heads the House Financial Services subcommittee that oversees the SEC, said the report "confirms that faster markets do not always lead to better markets." He said regulators must act quickly to revise market rules. If needed, Congress must "put in place new rules of the road to ensure the fair, orderly, and efficient functioning of the U.S. capital markets."
The flash crash called into question regulatory and technological changes over the last decade. "I do not expect today's report to restore the confidence lost as a result of the flash crash," said David Joy of Columbia Management, a large-money manager.
"Most individual investors do not fully understand how high-frequency trading works, only that it can create volatility and seems to put them at a disadvantage. Only time, and higher stock prices, will restore that lost confidence."