After extending the period for taking action several times, the Securities and Exchange Commission (the “SEC”) has approved proposals by each of the national securities exchanges and the Financial Industry Regulatory Authority (“FINRA”) (collectively, the “self-regulatory organizations” or “SROs”) to expand the coverage of the SROs’ uniform market-wide standards for pausing trades in certain securities that experience rapid price movements.1 As we discussed in earlier briefings, these “circuit breaker” rules were a response to the unprecedented market volatility on the afternoon of Thursday, May 6, 2010, often referred to as the “flash crash.”2
As originally adopted, the circuit breaker rules call for a pause in the trading of any component stock of the S&P 500 Index if the price of that stock moves 10 percent or more in the preceding five minutes.3 In such cases, the stock’s primary listing market will issue a five-minute trading pause and notify the other exchanges, FINRA, and market participants by immediately disseminating a special indicator over the consolidated tape. Once the primary listing market issues a trading pause, the other exchanges will pause trading in that security on their markets, and FINRA will pause trading by FINRA members in the over-the-counter (“OTC”) market (including alternative trading systems and market makers).4 At the end of a trading pause, the primary listing market will reopen trading in the security, and trading will resume on other markets once that occurs. If there is a significant imbalance on the primary listing market at the end of the pause, the primary listing market may delay reopening; however, if the primary listing market does not reopen trading within 10 minutes of initiating the pause, the other markets may resume trading. FINRA will allow OTC trading once trading resumes on at least one exchange. The SROs began implementing the circuit breaker rules on Friday, June 11, 2010, and they are effective on a pilot basis through December 10, 2010.
On June 30, 2010, the SROs filed proposals to expand the universe of covered securities to include stocks in the Russell 1000 Index and a proposed list of specified Exchange Traded Products (“ETPs”).5 The Russell 1000 securities were added because they have trading characteristics similar to those of the S&P 500 securities (indeed many of the same securities are included in both indices) and therefore the circuit breaker thresholds are appropriate for such securities. The ETPs that were proposed to be added were those with component securities that largely track the securities included in the S&P 500 and Russell 1000. 6 On September 10, 2010, the SEC approved the expansion of the circuit breaker program to include the Russell 1000 Index stocks and selected ETPs.7 The SEC anticipates that the exchanges and FINRA will begin implementing the expanded circuit breaker program during the week of September 13th. The SROs are expected to continue using the pilot period to make adjustments to the parameters or operation of the circuit breakers as they develop experience in the operation of the circuit breakers.
Erroneous Trade Rules
On September 10, 2010, the SEC also approved new SRO rules for breaking erroneous trades.8 The rules are intended to clarify when, and at what prices, trades will be broken by the SROs, and, like the circuit breaker program, will be in effect on a pilot basis through December 10, 2010. Under the new rules, the SROs will no longer have discretion to deviate from the specified thresholds for breaking trades in many situations, including those where the circuit breakers are applicable and in certain “Multi-Stock Events” involving five or more securities.9 The SEC and the SROs hope that this will help to provide certainty with respect to which erroneous trades will be broken, allowing market participants to better manage their risks.
The new rules provide that trades in stocks that are subject to the circuit breaker program will be broken at specified levels depending on the stock price:
- Trades in stocks priced at $25 or less will be broken if they are at least 10 percent away from the circuit breaker trigger price;
- Trades in stocks priced above $25 but no more than $50 will be broken if they are five percent away from the circuit breaker trigger price;
- Trades in stocks priced above $50 will be broken if they are three percent away from the circuit breaker trigger price.
Where the circuit breakers do not apply, the SROs will break trades at specified levels based on how many stocks are involved:
- For events involving between five and 20 stocks, trades will be broken if they are at least 10 percent away from the “reference price,” generally the price of the last sale before pricing was disrupted;
- For events involving more than 20 stocks, trades will be broken if they are at least 30 percent away from the reference price.
According to the SEC press release announcing the latest rule changes,10 the SEC staff also is considering whether market makers should be subject to more meaningful obligations to promote fair and orderly markets; working with the exchanges to prohibit the use by market makers of “stub” quotes that are not intended to indicate actual trading interest;11 and studying the impact of multiple exchange trading protocols, including the use of exchange-specific trading pauses and the Regulation NMS selfhelp rules. The SEC also is looking to work with the markets and the Commodity Futures Trading Commission with an eye toward recalibrating the market-wide circuit breakers that apply across all equity trading venues and the futures markets, which were not triggered on May 6 despite the extraordinary market volatility.