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Threat of new ‘flash crash’ looms over markets – experts

Tuesday, June 22, 2010
Opalesque Industry Update – Just when the markets thought the May 6 “flash crash” was already history and its repeat very unlikely with the introduction of the new “circuit breaker” rule by the Securities and Exchange Commission (SEC), market experts said that the threat of a new crash looms large over Wall Street.

A good number of market traders and legislators agree that the May 6 incident, which saw the Dow Jones lose nearly 1,000 points in minutes, represents a larger problem symptomatic with high-frequency trading and lack of concrete policy to prevent future occurrences, reported

Doug Roberts, chief investment strategist at Channel Capital Research, criticized the lack of global framework within the markets that deals in a global trading system. He said this makes the markets prone to flash crashes.

U.S. Senator Ted Kaufman warned of an imminent danger and added: “We are playing with dynamite here,” as he pressed for the SEC and Congress to address the flash crash problem.

Two “mini-flash crashes” recorded this month triggered fresh concerns. Last Wednesday (June 16), the Washington Post’s shares doubled inside of a second from nearly $460 to $929.18, while the tech services company Diebold saw its shares plunge 35% then recover in a period of a few minutes on June 2.

Regulators introduced reforms to prevent flash crashes
Early this month, the SEC introduced circuit breakers that would halt trading if an individual stock declines by 10% in five minutes.

In May, the SEC required national securities exchanges to provide regulators data so that they can aggregate real-time market information across multiple platforms.

These reforms were supported by industry experts in a roundtable discussion sponsored by the SEC this month. Market experts said the flash crash can be avoided with the introduction of structural reforms.

Confluence of events or not everybody was on the same page?
SEC Chairman Mary Schapiro announced on June 10 that their investigation into the May 6 flash crash had concluded that a confluence of factors had led to the unprecedented event. Although she said her agency would still dig deeper to find its real cause.

However, participants in the latest Opalesque Roundtable in Boston said the event was not caused by market manipulation or monopoly but because “not everybody was on the same page” that day. Alec Petro, Managing Partner at Bay Hill Capital Capital Management, a volatility-focused, multi-strategy hedge fund based in Massachusetts with $130m in AuM, said there was just too much data and very large liquidity that day. Also, “guys like us turned our machines off” that day (See Opalesque Exclusive: here) .

Digging into the May 6 ‘flash crash’
Initial investigations made by the Commodities Futures Trading Commission (CFTC) and the SEC showed that regulators were only “slightly closer to understanding the flash crash events of May 6.” In the 151-page report released 12 days after the event, both the SEC and the CFTC basically admitted that “their guess is as good as ours.”

Research firm Investment Technology Group Inc said that exchange traded funds (ETFs) were more affected by the flash crash that any other category of securities. Many blamed ETF failures on May 6 on either a problem in the U.S. market structure, or a problem with ETFs as a product (See Opalesque Exclusive: here) .

A report by Reuters cited a document from the Chicago Mercantile Exchange parent CME Group which pointed to wealth manager Waddell & Reed Financial Inc. as the alleged culprit of the May 6 market plunge. Waddell, which manages the $22.1bn Ivy Asset Strategy fund, was said to have sold a large order of e-mini contracts during the 20-minute span when the Dow Jones plunged that wiped out an estimated $1tln in market capital.

Original flash crash of 1962
According to an article published by, the original flash crash occurred on May 28, 1962 when the Dow Jones Industrial fell 9% in less than 12 minutes. As in the case of this year’s market plunge, the SEC also launched an investigation into the 1962 event but came out with no clear explanation as to its cause.

One of the recommendations then was for “special provisions in respect to the handling of stop sell orders or market sell orders.” Similarly, last month, SEC Commissioner Elisse Walter has called for an examination of market orders. It seems the markets and regulators have not learned from past mistakes.
-Precy Dumlao


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