UPDATE 4-Panel urges big thinking in 'flash crash' response

Wed Aug 11, 2010 5:00pm EDT

* Execs, advisory committee meet heads of CFTC and SEC

* SEC mulling smaller fixes; some want rethink

* Whipsawed investors retreated since May 6 breakdown

* Gensler: follow-up report on crash in early September (Adds Schumer comment, graphic)

By Jonathan Spicer and Roberta Rampton

WASHINGTON, Aug 11 (Reuters) - U.S. securities regulators said on Wednesday they are working on technical fixes for the still-unexplained May "flash crash," but some market players say they want a wholesale review of high-speed trading.

A regulatory advisory committee is probing exactly what went wrong during the May 6 crash, which sent the stock market plunging 700 points within minutes and is weighing adjustments to prevent it from happening again.

The committee, a joint effort of the Securities and Exchange Commission and the Commodity Futures Trading Commission, brought together money managers, brokers and academics at a hearing on Wednesday to get their views on what happened and how to fix it.

"We don't have a rule here that was broken that caused this," said CFTC Commissioner Michael Dunn after the hearing, urging the advisory panel to recommend "rules of the road" to prevent a repeat performance.

"One thing really struck me today ... hearing from these panel members that what happened on May 6 can happen again. In fact they expect it to happen again,"

The SEC has employed stock-trading pauses called circuit breakers and also has instituted better auditing of all buy and sell orders.

SEC Chairman Mary Schapiro said a fast fix that calmed the market was needed. She also listed technical areas that may yet need changes, including the use of so-called market orders, stub quotes, price collars and self-help rules used by the dozen U.S. exchanges where today's high-speed trading is done.

Some of those at the CFTC-hosted meeting said fragmented markets and the explosion of high-frequency algorithmic trading may warrant a wider revamp of the marketplace.

"We believe a more fundamental consideration is warranted, and this is whether the current market structure has become too focused on the speed of execution over all other factors," said Kevin Cronin, director of equity trading at money manager Invesco Ltd (IVZ.N).

"At some point, we believe that speed and price discovery have an inverse relationship, and this dynamic needs to be well-understood."

The SEC said it is considering collars on market orders to keep them relatively close to a reference price, and whether to deter or regulate stub quotes, in which market makers quote well off the public price of stocks. [ID:nN02100543]

Chris Nagy, TD Ameritrade Holding Corp's (AMTD.O) managing director of order routing, said collars would hurt his brokers' clients. "What we need to look at is addressing the structure of the markets more," he said. "There was a complete evaporation of liquidity in the marketplace" during the crash.

Influential senator Charles Schumer weighed in on Wednesday, broadening his criticisms of the fragmented marketplace and flash orders to include high-frequency firms that "effectively" make markets in 25 or more stocks.

Schumer urged the SEC to place these firms under "a uniform set of rules to prevent them from pulling out of markets en masse as they did during last May's flash crash..."

SEPTEMBER FOLLOW-UP REPORT

In early September, regulatory staff will issue a "follow-up report" on the crash, CFTC Chairman Gary Gensler said. The advisory committee will consider the report and make recommendations, perhaps in October, he said.

Regulators and exchanges have thus far pointed to a rare alignment of events on May 6 in the electronic marketplace in which stocks, futures and exchange-traded funds traded simultaneously on dozens of venues at some record volumes.

Disparate exchange rules, a lack of liquidity and market jitters over Europe's escalating debt crisis are believed to have played a role in the flash crash. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Graphics on the May 6 plunge: link.reuters.com/cej92k link.reuters.com/wat23k ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

Schapiro said the process of breaking thousands of erroneous trades after the crash was "neither clear nor transparent" and has created uncertainty for investors about how such trades would be handled in the future. The SEC has proposed rules for trade-breaking.

Although exchanges canceled thousands of trades after markets closed, the crash brought steep losses to some. Goldman Sachs Group Inc (GS.N) this week cited May's volatility as a factor in why it had 10 days of trading losses in the second quarter. [ID:nN09261133]

Invesco's Cronin told the committee that the prospect of trade breaking likely exacerbated the plunge that afternoon. Charles Rotblut, vice president of the American Association of Individual Investors, said one of the crash's biggest impacts was on investor confidence.

Trading volumes have dropped precipitously from the record highs reached in May, and worries have grown that whipsawed investors, particularly individuals, have retreated from the sharp volatility. [ID:nN12238251]

David Ruder, joint committee member and a former SEC chairman, said it seems that these type of events will continue. "I just don't know what we can do to avoid this kind of computer-generated loss of confidence." (Reporting by Jonathan Spicer and Roberta Rampton; Editing by Derek Caney, Maureen Bavdek, Gunna Dickson, Steve Orlofsky and Robert MacMillan)

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